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THE NEXT STEP IN SMALL AND MEDIUM ENTERPRISE LENDING
David Alexander Stroud B. Com., University of British Columbia, 1997
A PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF
MASTER OF BUSINESS ADMINISTRATION
In the Faculty of
Business Administration EMBA Program
O David Alexander Stroud 2004
SIMON FRASER UNIVERSITY
August 2004
All rights reserved. This work may not be reproduced in whole or in part, by photocopy
or other means, without permission of the author.
ABSTRACT
This project examines the business lending industry in Canada and the strategic
direction of the small and medium enterprise (SME) lending business of the Toronto-
Dominion Bank Financial Group (TDBFG). TDBFG is one of the largest schedule I
banks in Canada, however its market share of the SME lending market is substantially
less than its market share in other business segments.
This paper will assess the current environment in which the Bank operates and
identify key success factors in the SME financing business. It will then present TDBFG's
optimal strategy going forward as well as an alternative strategy. An evaluation of
TDBFG's current internal capabilities will determine whether the Bank is capable of
executing the optimal strategy or should instead undertake alternative strategy.
Presently the SME customer category is served by both the small business banking arm
of the TD Canada Trust and the TD Commerial bank and as a result any recommended
solutions will focus on these two business units.
APPROVAL
Name:
Degree:
Title of Thesis:
Supervisory Committee:
David Stroud
Master of Business Administration
The Next Step in Small and
Medium Enterprise Lending
Dr. Neil Abramson Senior Supervisor Associate Professor Faculty o f ~ i n e s s ~ m i n i s t r a t i o n
Supervisor (1 Associate Professor Faculty of Business Administration
Date Approved: - 0 - b y
Executive MBA Program
Partial Copyright License
I hereby grant to Simon Fraser University the right to lend my thesis, project or extended essay (the title of which is shown below) to users of the Simon Fraser University Library, and to make partial or single copies only for such users or in response to a request from the library of any other university, or other educational institution, on its own behalf or for one of its users. I further agree that permission for multiple copying of this work for scholarly purposes may be granted by me or the Dean of Graduate Studies. It is understood that copying or publication of this work for financial gain shall not be allowed without my written permission.
Title of Thesis/Project/Extended Essay
The Next Step in Small and Medium Enterprise Lending
Author:
ba-
Date
DEDICATION
This paper is dedicated to Isabelle. My work over the past two years pales in
comparison to her love, hard work, dedication and sacrifice throughout my lifetime in her
unrelenting drive to help me realize my potential. My dream is to make her proud.
ACKNOWLEDGEMENTS
Over the past two years many individuals have provided encouragement and
support towards the attainment of my degree and completion of this program. First I
would like to thank my best friend Ed Fidler and brother Chris Stroud for your support,
encouragement and friendly rivalry. I thank John Stroud-Drinkwater for his efforts to
assist me through the last stretch. I thank my two managers throughout the program,
Jim Yee and Ruth Lee for providing support towards my endeavour and acknowledging
my efforts in furthering my education. Finally, I thank my team members, cohorts and
professors through whom I acquired my knowledge and sharpened my critical thinking.
TABLE OF CONTENTS
. . Approval ........................................................................................................................ 11
... Abstract ........................................................................................................................ III Dedication .................................................................................................................... iv
Acknowledgements ....................................................................................................... v
Table of Contents ....................................................................................................... vi ... List of Figures ............................................................................................................ VIII
List of Tables .............................................................................................................. ix
Glossary or List of Abbreviations and Acronyms ....................................................... x
1 Chapter One: Small & Medium Enterprise Lending At The TD Bank Financial Group ................................................................................................... 1
The Toronto Dominion Bank Financial Group ........................................ 1 The Corporate Group ................................................................................... 3 TD Canada Trust ......................................................................................... 4 Business Banking & Insurance .................................................................... 7
.................................................................................... Wholesale Banking 10 Wealth Management .................................................................................. I I
................................................................................. TD Waterhouse USA 12 Focus of this Strategic Analysis ................................................................. 12
Chapter Two: The SME Lending Industry ........................................ 14 Business Lending Defined ......................................................................... 14 Industry Analysis ....................................................................................... 14
............................................................................................. New Entrants 17 Suppliers ................................................................................................... 21
................................................................................... Customers Analysis 23 Substitutes ................................................................................................. 29 Value Chain Analysis ................................................................................. 31 Securities Underwriting .............................................................................. 32 Marketing ................................................................................................... 33 Distribution ................................................................................................ 34 Loan Production & Credit Management ..................................................... 37
..................................................................................................... Service -39 Competitive Analysis ................................................................................. 41 Competitive Concentration is high ............................................................. 44 Increased Competitive Pressure from Mature Market ................................ 44 Commoditization of Banking Products and Services .................................. 44 Technology Enables the Easy Switch ........................................................ 45 High fixed assets costs .............................................................................. 45 Brand Equity Costs and Political Barriers to Exit ........................................ 46 Key Success Factors ................................................................................. 46 Culture ....................................................................................................... 46
................................................................................................... Marketing 47 Sales & Distribution ................................................................................... 48 Systems and Processes ............................................................................ 49 Credit Policy & Risk Management .............................................................. 50
................................................................................. The Current Strategy 50 Core Strategy ............................................................................................ 51 Optimal Rapid Penetration Strategy ........................................................... 52
. ~
Culture ....................................................................................................... 53 ................................................................................................... Marketing 53
Sales & Distribution ................................................................................... 54 Systems and Processes ............................................................................ 56 Credit Policy & Risk Management .............................................................. 60
...................................................... Alternative Rapid Penetration Strategy 61 ......................................................................... Credit Scoring Technology 63
................................................................ Credit Management Technology 63 .................................................... Organization & Compensation Structure 63
................................................................................ Product Development 64
Chapter Three: Internal Analysis of SME Lending at TDBFG ............... 65 ................................................................................................. Resources 65
Culture ....................................................................................................... 65 Marketing ................................................................................................... 66 Sales & Distribution ................................................................................... 66 Systems & Processes ................................................................................ 68 Credit Policy & Risk Management .............................................................. 71 Resource Gap ........................................................................................... 71
......................................................................... Management Assessment 73 Management Gap ...................................................................................... 74 Organization .............................................................................................. 75 Organizational Capabilities ........................................................................ 75
............................................................................ Organizational Changes 76 ...................................................................................... Organization Gap 78
Chapter Four: Recommendations .......................................................... 80 ................................................................................................... Overview 80
Strategic Recommendation ........................................................................ 80 The Vision ................................................................................................. 80
..................................................................................................... Urgency 81 ............................................................................................. Project Team 81
The Devil in the Details .............................................................................. 83 .................................................................................................... Vigilance 86
............................................................................................... Conclusions 86
.............................................................................................. Appendices 88 Appendix A: Business Loan Product Life Cycle ........................................ 88 Appendix B: SME Banking Reporting Structure ........................................ 89
............................................. Appendix C: Loan Application Process Flow 90 ................................................ Appendix D: Customer Experience Model 91
Bibliography ............................................................................................. 92
LIST OF FIGURES
Figure 1 : TD Bank Financial Group Corporate Structure ................................................ 2 Figure 2: TDBFG Revenue by Business ......................................................................... 3
....................... Figure 3: Personal and Commercial Banking Revenue by Business Unit 4
....................................................................... Figure 4: 9 Regions of Retail Distribution 5 Figure 5: Branch Reporting Structure ............................................................................. 6 Figure 6: Total Credit Authorizations for Firms with Authorizations under $1
million ............................................................................................................ 15 Figure 7: Competitive Analysis Chart of SME Lending in Canada ................................ 16 Figure 8: Authorization Sizes of SMEs Borrowing from Domestic Banks ...................... 24 Figure 9: Breakdown of SME Liabilities by Type. 2000 ................................................. 29 Figure 1O:SME Lending Value Chain ............................................................................ 31 Figure 1 1 :SME lending market share statistics .............................................................. 43
........................................................................... Figure 12: Enterprise Risk Framework 77
viii
LIST OF TABLES
Table 1: Table 2: Table 3: Table 4: Table 5: Table 6: Table 7: Table 8:
Table 9:
Global Bank Rankings by Assets .................................................................. 15 SMEs' Sectors of Operations by Region in 2000 ........................................... 25 Sources of SME Financing ............................................................................ 29 Analysis of small business banking at the 5 largest Canadian banks ............ 42 Business Segmentation under Optimal Strategy ........................................... 54 Business Segmentation under Alternative Strategy ....................................... 63 Resource Strengths and Weaknesses .......................................................... 72 Management Strengths and Weaknesses ..................................................... 74 Organization Strengths and Weaknesses ...................................................... 79
GLOSSARY OR LIST OF ABBREVIATIONS AND ACRONYMS
ACC BMO BNS Cl BC CRM ERP FA FSR GDP GRM HSBC MCC MSBBS RBC ROI SBA SBB SME TDBFG TDCT
Area Credit Centre Bank of Montreal Bank of Nova Scotia I ScotiaBank Canadian Imperial Bank of Commerce Customer Relationship Management Enterprise Resource Planning Financial Advisor Financial Service Representative Gross Domestic Product Group Risk Management Hongkong and Shanghai Banking Corporation Manager Commercial Credit Manager Small Business Banking Sales Royal Bank of Canada Return on Investment Small Business Advisor Small Business Banking Small and Medium Enterprise Toronto-Dominion Bank Financial Group TD Canada Trust
1 CHAPTER ONE: SMALL & MEDIUM ENTERPRISE LENDING AT THE TD BANK FINANCIAL GROUP
Although the TD Bank Financial Group (TDBFG) has a robust 20.05 percent
market share in the Personal Banking arena, its share of small enterprise lending is 10.9
percent and medium enterprise lending is 9.2 percent.' This represents a very large
opportunity to the TDBFG because it implies that many of its personal customers have
business dealings with other Canadian banks and that they can potentially be cross sold
business financing. It also represents lost opportunities in the past, since the Bank has
had a smaller market share in the SME market for some time and its current strategy
has failed to close the gap. The Bank's leadership has recognized the value of this
opportunity and has appointed an Executive Vice President, Bernard Dorval, to preside
over this market segment in addition to the insurance group, as both of these markets
have been identified as high growth opportunities for the Bank.
This paper will examine the competitive environment in the SME lending market
and recommend an optimal and alternative strategy for TDBFG to execute, both of which
could bring a bank success in gaining SME lending market share. Given these
strategies, an audit of TDBFG's internal capabilities will qualify which strategy TDBFG is
capable of executing successfully.
1 .I The Toronto Dominion Bank Financial Group The Toronto Dominion Bank Financial Group was originally founded in 1955 as
the Toronto Bank, which in 1955 amalgamated with the Dominion Bank, which was
chartered in 1869. Since its inception, the Bank has grown through organic growth, as
1 Market share statistics represent a percentage of customers dealing with Canadian chartered banks and deal not include non-bank financing to the SME market.
well as mergers and acquisitions. Most recently the Bank purchased CT Financial
Services Inc., which vaulted the Bank from 5'h largest bank by assit size to 2nd largest,
behind the Royal Bank. Over time, the Bank has also broadened the scope of financial
products offered and as a result has become a group of companies selling financial
services to retail and institutional customers in Canada and abroad.
TDBFG has over 51,000 employees and more than $31 6 billion in assets. As
seen in Figure 1, it is comprised of three key business areas: Personal & Commercial
Banking, Wealth Management and Wholesale Banking.
Personal & Wealth Commercial Banking I Wholesale Banking I Management
Figure 1: TD Bank Financial Group Corporate Structure
TDBFG derives the majority of its revenues from its Personal and Commercial
Business. As seen in Figure 2, this business unit generated 58 percent of revenues in
2003 and it is considered to be TDBFG's core business.
Wealth Management
21 %
Wholesale Banking
21 %
Figure 2: TDBFG Revenue by ~ u s i n e s s ~
TDBFG delivers services to the small and medium enterprise market through the
Personal and Commercial Banking business. SME financing is delivered to the
customer under two brands, TD Canada Trust and TD Commercial Bank. The TD
Canada Trust is a brand that represents TDBFG's retail operations. TD Canada Trust
distributes Personal Banking, Small Business Banking and Wealth Management
products. TD Canada Trust has approximately 10 million personal, small business and
insurance customers. TD Commercial Bank operates parallel to TD Canada Trust and
services medium enterprises, mid-market customers and junior corporate.
As a result of the acquisition of CT Financial Services Inc. in 1999, the retail
banking operations of TD Bank and Canada Trust were merged. Under the brand name
TD Canada Trust, the combined operation is one of Canada's premier retail banking
organizations. Branch conversions to TD Canada Trust branding were successfully
completed in August 2001.
1 .I .I The Corporate Group
The corporate group provides support services, infrastructures and direction in
areas that are common to the three bank businesses. Corporate Group's mandate is to
provide centralized advice and counsel and to design, establish and implement
Source: TD Bank Financial Group Annual Report 2003. Other revenue includes internal commissions on sales of mutual funds and other Wealth Management products, fees for foreign exchange, safety deposit box rentals and other branch services.
processes, systems and technologies to ensure that the Bank's ke. businesses operate r efficiently, effectively and in compliance with all applicable regulations.
1.1.2 TD Canada Trust
TD Canada Trust represents the Personal and Commercial Banking arm of the
TDBFG. It offers banking services to customers in Canada, under the TD Canada Trust
Brand, and in the U.S., under the TD Waterhouse Bank Brand. Financial services are
delivered through a network of branches, the Internet, the telephone, and most recently
through wireless devices such as pagers and cell phones. TD Waterhouse Bank is the
largest electronic bank in the U.S. offering a full suite of personal products and services.
TD Canada Trust represented 82 percent of TDBFG's income on a cash basis in 2003
and as per Figure 3, 21 percent of its revenue is derived specifically from business
banking. This implies that were the Bank to meet its expectations to double its market
share in SME lending, it could increase revenue by up to 20 percent.
insurance Other 4%
Commercial 8% Bank 10%
Personal Small Banking
Business 67% Banking
11%
Figure 3: Personal and Commercial Banking Revenue by Business Unit
1 .I .2.1 Retail Distribution
Retail Distribution is divided into 9 regions in order to manage the banking
network across Canada's large geographic area. The majority of the Bank's branches
are located in Ontario and as a result Ontario has 5 regions. As seen in Figure 4 below:
Ontario
Greater Toronto
Ontario North 81
Figure 4: 9 Regions of Retail Distribution
Retail Distribution is supported by e. Bank, Retail Sales & Service, as well as
Retail Transformation. e.Bank supports TD Canada Trust by completing billions of
transactions annually and selling millions of units of products through call centres,
internet banking and the ABM network. EasyWeb, the Bank's internet banking platform,
has been recognized with several awards recognizing its best-in-class design and
functionality and the Bank is recognized as an industry leader in web banking market
penetration.
Retail Sales & Service is an integrated team dedicated to fulfilling five key
functions: Sales & Service Support, Advice & Channel Support, Retail Real Estate
Management, Branch Optimisation, and Retail Operational Risk. Sales & Service
Support is available through a bank intranet and a call centre to assist employees
throughout the retail network with product knowledge, compliance and systems use.
Advice and Channel Support are a team of specialists within each region who train
employees and regularly visit individual branches in each region to provide coaching.
The other three focuses support the operational functions of the retail network.
1.1.2.2 The Regions
Each region is composed of over one hundred branches a ri d is sub-divided into
districts with up to 20 branches per district. Each region may have its own unique
focuses. For example, Pacific Region has departments in several branches devoted to
Asian banking, which provides banking services in Korean, Japanese, Cantonese,
Mandarin, Punjabi and Hindi. The Prairie Region on the other hand has several
branches with agricultural lending departments.
1.1.2.2.1 The Branches
Each Branch Manager reports to a District Manager, and each branch must focus
on both sales and service. The Manager Customer Service reporting to the Branch
Manager, oversees the frontline Customer Service Representatives (Tellers) and
Greeter (Receptionist) area. The Branch Manager directly oversees the sales staff:
Small Business Advisors, (SBA) Financial Advisors (FA) and Financial Service
Representatives (FSR). In larger branches this supervision is shared between the
Branch Manager and a Manager Financial Services as illustrated in Figure 5. Only
branches with large Small Business loan portfolios will be assigned a Small Business
Advisor.
Branch Manager 7
Figure 5: Branch Reporting Structure
1 .I .3 Business Banking & lnsurance
Business Banking and lnsurance are part of the TD Canada Trust and these two
businesses have been singled out as key opportunities to the Bank. Because of the high
potential of these businesses, the Executive Vice President (EVP) of this group reports
directly to the CEO while still working closely with the President and other EVPs within
TD Canada Trust.
Business and lnsurance Group manages all aspects of the commercial and small
businesses customer experience from product development through to credit
adjudication, product support, and sales distribution. The Bank believes that by aligning
the Commercial Banking, Small Business Banking and Merchant Services teams the
three groups will work together seamlessly to serve business customers and become the
best business bank in North ~ m e r i c a ~ .
The Group also manages TD Canada Trust's insurance products, which include
creditor insurance, international reinsurance, and home & auto insurance.
1.1 .%I Commercial Banking
TD Commercial Banking serves needs of businesses whose borrowing needs
are too complex for the Small Business Banking product suite. Commercial banking
affords more customized financing solutions and involves a greater depth of financial
analysis and due diligence.
TD Commercial Bank offices are primarily found in large urban centres located in
the same building as a TD Canada Trust branch. Customers of TD Commercial Bank
use services provided by the retail bank such as teller services, ATMs and day to day
banking. Commercial banking focuses on providing products and services to Canadian
Merchant Services provides card payment solutions to business customers who need to accept payment using credit cards and debit cards.
large and
investing,
medium sized enterprises. The full suite of products inc!udes lending,
cash management, foreign exchange, trade finance andltreasury products.
Commercial banking is divided into two primary functional areas Credit
Adjudication and Sales. Both functional areas are sub-divided into five regional areas
with a sixth department serving the junior corporate customers who have borrowing
needs in excess of $5 million.
A loan request from a customer new to the Commerial bank would take the
following path. Let us suppose that the customer first met a Manager Business
Development at a Chamber of Commerce function. The Manager of Business
Development would then introduce the customer to a Relationship Manager, who would
then interview the customer and assess her needs. The Relationship Manager would
then structure the deal with the assistance of an Analyst and together they would
escalate the deal to the Manager Commercial Credit (MCC) in their office. The deal is
reviewed by the MCC and she is willing to recommend it, however since it is above her
limit she escalates it to Group Risk Management (GRM) at the regional level. At GRM
two underwriters review the credit and authorize it. If the amount had been much larger,
they would have had to escalate it to Toronto. Six employees have touched the deal
since the first contact with the customer. If GRM had not approved the deal, the
Relationship Manager and Analyst might have restructured it and begun the process
once again.
At the branch level, the Manager Business Development and Relationship
Managers report to a Manager Commercial Sales. The analysts report to the Manager
Commercial Credit. The Manager Commercial Credit reports to Group Risk
Management, whereas the Manager Commercial Sales reports to a District Manager.
The structure is designed to nullify a potential conflict of interest that could occur if the
risk manager were to have sales targets.
1.1.3.2 Small Business Banking and Merchant Services
Small Business Banking delivers products and services that are tailored to meet
the banking needs of small businesses who have relatively simple banking needs that
can be served in a retail branch. A common service used by our small business
customers is Merchant Services. Merchant Services provides card payment solutions to
customers who need to accept payment using credit and debit cards.
1.1 -3.2.1 Small Business Banking Product Group
Small Business Banking Product Group is composed of three functional areas:
Product & Distribution, Agriculture & Franchise Banking, and Small Business Credit.
Product & Distribution is concerned with designing deposit and credit products with
respect to pricing process and promotion. This group develops and executes an annual
marketing plan and must engage multiple distribution channels and business units.
Agriculture and Franchise Banking develops and markets special pricing and
loan guidelines for agricultural businesses and established franchise networks. The
Bank recognizes that these two groups have different risk profiles than the broader
market and therefore require customized solutions. The Product & Distribution unit has
designed a similar pricing and loan package for Professionals, however it is less
formalized than the Agriculture and Franchise packages.
Small Business Credit is composed of two credit adjudication centres. Eastern
Credit Centre is located in Markham, Ontario and Western Credit Centre in Edmonton,
Alberta. Small Business Advisors structure loan submissions and send them to one of
the credit centres to be adjudicated. The centres are organized into teams of up to
seven Underwriters working under one Senior Underwriter. Higher limit deals and deals
i that are declined are all escalated to the Senior Underwriter for a second review.
1.1 A2.2 Small Business Banking Sales
The Manager Small Business Banking Sales (MSBBS) is the individual who
provides sales support to people in the branch network to assist in the sales and
distribution of small business products and services. They provide product and market
information to Small Business Advisors, and they train and coach Financial Advisors and
Financial Service Representatives. The MSBBS reports to a Regional Manager of Small
Business Banking Sales who in turn reports to the Assistant Vice President of Small
Business Banking Sales in Toronto. It is significant to note that SBA's do not report to
any part of the Small Business Banking Sales group.
1 . I .4 Wholesale Ban king
Wholesale Banking, distributed under the TD Securities brand offers a variety of
capital market products and services to corporate, government and institutional
customers in five key finance areas.
Through its Investment Banking division, TD Securities provides services and
advice to clients to assist them in mergers and acquisitions, divestitures, capital
structuring and risk management. lnvestment Banking also provides services in the
placement of common equity, preferred shares, private equity, debt securities, debt
syndications and bridge financing.
TD Securities' Debt Capital Markets division provides its global client base with
origination, trading and sales of money market, investment and non-investment grade
fixed income instruments as well as derivatives.
The Institutional Equities division, under the TD Newcrest brand, provides equity
sales, trading, research, underwriting and distribution in North America.
The Private Equity division, under the TD Capital brand, provides equity and
mezzanine financing to middle-market customers in order to finance management
buyouts, expansion, acquisitions, industry consolidations and recapitalizations.
Finally, the Foreign Exchange division provides foreign exchange spots, forwards
and options.
1 . I .5 Wealth Management
Wealth Management provides a wide array of investment products and services,
the majority of which are provided through three key businesses: TD Mutual Funds, TD
Private Client Group and TD Waterhouse Canada.
1.1.5.1 TD Mutual Funds
TD Mutual Funds offers more than 70 mutual funds and 30 managed portfolios.
These funds are distributed through the retail branch network, TD Waterhouse's
discount and full brokerage as well as in house financial planners. The funds are also
distributed through external brokers and financial planners.
1.1 S.2 TD Private Client Group
TD Private Client Group provides discretionary account management to clients
with large investment portfolios. This group also provides estates and trust services as
well as insurance products for wealth protection. The Private Banking Group is also
division of TD Private Client Group.
1.1.5.3 TD Waterhouse Canada
TD Waterhouse Canada offers brokerage services and no-fee financial planning.
Customers can choose from discount brokerage or full brokerage services. Discount
brokerage provides low cost access to stock market trading for customers who want to
I make their own investment decisions without the benefit of a broker's advice. Trading is
accessible by phone or the Internet and market information is provided via the website
and direct mail. Full brokerage, called TD Waterhouse Investment Advice provides
trading services and advice along with active account management. TD Waterhouse
Financial Planning accounts do not allow trading in stocks, however they do provide no
fee full financial planning and the ability to invest in mutual funds, money market and
fixed income instruments.
1.1.6 TD Waterhouse USA
TD Waterhouse USA provides discount brokerage services to customers in the
United States. TD Waterhouse USA has over 2.1 million customers and over $108
billion in customer assets.
1.2 Focus of this Strategic Analysis TD Canada Trust presently has a three-pronged strategy. The primary initiative
involves preserving and improving on the Bank's core competency in expense
management and efficiency. The second initiative is the Bank's commitment to deliver
superior service and a premium brand based customer experience. This premium brand
will be leveraged to extract lifetime value of the customer by improving customer
retention, customer attraction and cross selling to current customers. The last piece of
the Bank's strategy is to focus on growth of under penetrated businesses that have the
potential for above average growth rates. These "super growth" business units are
commercial banking, small business banking and insurance.
This paper will assess the current environment in which the Bank operates and
identify key success factors in the SME financing business. It will then examine
TDBFG's current internal capabilities, and recommend whether TDBFG should
undertake an optimal strategy or an alternative strategy given its current capabilities.
Presently the SME customer category is served by both the small business banking arm
of the TD Canada Trust and the TD Commercial Bank and as a result any recommended
solutions will focus on these two business units.
i CHAPTER TWO: THE SME LENDING INDUSTRY
Business Lending Defined The small and medium sized enterprises (SME) market segment typically
consists of organizations with fewer than 500 employees, $50 million in revenues and
are owner operated. The Canadian Bankers Association defines small enterprises as
those businesses with authorised borrowing levels under $500,000 and medium
enterprises as those with levels under $1,000,000. SMEs are critical to the Canadian
economy, make up 43 percent of Canada's GDP, and are the primary engine for job
~ rea t ion .~ While SMEs are good for the Canadian economy, they are also a great
opportunity for financial institutions in Canada. In 2001, authorized debt financing to
SMEs reached almost $149 billion of which only 49 percent was supplied by the 14
domestic banks.5 The other 51 percent is supplied from non-bank source^.^
2.2 Industry Analysis Canada is a small player on the world financial stage, which is not surprising
given its relative GDP and population. It represents only 2.4 percent of the world's
equity market capitalization, down from 3.8 percent in 1982 and had only a 2.9 percent
share of global personal financial services and insurance profits in 1998.~ As seen in
Table 1, ranked by assets, not one of Canada's banks rank in the top 50 globally.
Canada. Industry Canada. Key Small Business Statistics. Ottawa, April 2004: 22 5 Canada. Statistics Canada. Survey of Suppliers of Business Financing 2002 6 See Figure 6 below. 7 McKinsey & Company, The Changing Landscape for Canadian Financial Services: New forces, new competitors, new choices, Ottawa: Department of Finance, September 1998: 1 1
pank [Bank ]Bank Country U.S. Japan Switzerland Japan
1 2 3 4 5
51 60 64 65 66
Canada Canada Canada Canada
Citigroup Mizuho Financial Group UBS Sumitomo Mitsui Financial Group Deutsche Bank Royal Bank of Canada Scotiabank The Toronto-Dominion Bank Canadian Imperial Bank of Commerce Bank of Montreal
A'ssets ($ millions CDN) ' ]
Table 1: Global Bank Rankings by ~ssets '
In Canada's SME financing market it appears that banks are the preferred
supplier of financing. However, even though the major banks dominate the market with
49 percent market share, as seen in Figure 6, there are many other players in this
market. The SME financing market size is approximately $1 46 bi~l ion.~
Other Banks & Tmst Companies
6%
Credit Unions 1 Caisses Populaires
18% 1 Domestic Banks 49%
Finance Compani 24%
Pollfolio Managers, I"surance & v c c s 1 Leasing Companies 1 % 2%
Figure 6: Total Credit Authorizations for Firms with Authorizations under $1 millionlo
8 Source: The Banker, July 2003 Canadian Bankers Association. Competition in the Canadian Small and Medium-sized Business
Financing Market. Dec. 2000: 2 10 Canadian Bankers Association, Competition 3
A five forces analysis of the SME financing market reveals a very competitive
marketplace." As seen in Figure 7, low barriers to entry, high supblier and buyer power,
a high threat of substitutes and high competitive rivalry, characterize the market.
I Level of Significance 1 I Lowest * I Low * * I
Medium
High
Highest *.*+**
Economies of Scale
Lack of Buyer Concentrat_i= ** * * Competitive Concentration * ** * * A lncreasinoht com~lex , * * *
Figure 7: Competitive Analysis Chart of SME Lending in Canada
product offerings' Shifting Industry Growth ** Trends
11 Adapted from Porter, Michael E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: The Free Press, 1 980: 4
2.2.1 New Entrants
2.2.1.1 Legislative Changes are Increasing Ease of Entry
Before 2001, under the Bank Act no shareholder of a large bank could hold more
than 10 ownership. With the changes in brought about in Bill C-8, one
shareholder is now able to own up to 100 percent of a small bank and up to 20 percent
of a medium to large bank. This was expected to encourage the creation of more banks.
Telecommunications companies, grocery retailers, businesses with existing retail
networks or strong online presence that can be used to distribute banking services
would most likely launch these banks. Another legislative change, which increases ease
of entry, is the reduction in capital requirements needed to apply for a bank licence from
$10 million to $5 million. As of year-end 2003 there has not been significant new entry
although there are some interested parties.
Although legislation is facilitating entry, the federal government still retains
control of who can establish a new bank. In order to preserve a safe and stable financial
system, applicants must demonstrate the financial wherewithal, and management ability
to successfully operate a bank in Canada. The federal government must also approve
shareholders wishing to acquire 20 percent of a large bank.
Legislation now allows foreign banks to directly operate in Canada using a
branch network, rather than requiring them to set up a separately capitalized subsidiary.
This increases the capital availability of foreign banks operating in Canada since they
will be able to draw on the capital of the foreign parent company.
Prior to the passage of this legislation only deposit taking institutions could
access the payments system. This meant that other financial institutions could not
access the cheque clearing system, credit card systems or the lnterac network. Under
new law non-deposit taking institutions, such as insurance companies, securities dealers
and mutual fund companies have access to these networks and can offer their I
customers banking services.
2.2.1.2 Technology Reduces Entry Costs
The Internet has had a tremendous impact on banking. Although incumbent
bricks and mortar banks have made unsuccessful attempts at launching online
subsidiaries, ING Group has successfully proven the online banking business model.12
ING Direct was first launched in Canada in 1997 and presently has over 850,000
Canadian clients, and over $12 billion in assets. It has since used this winning business
strategy to enter 6 additional countries in Europe, North America and Australia. It is
possible for ING or another company to enter the SME financing market in the same
fashion.
Wells Fargo, a very successful SME lender from the United States, which
entered the Canadian SME loan market in 1999 using an electronic platform and a direct
mail marketing campaign met with limited success and subsequently exited the market.
The online banking business model reduces capital costs associated with a
physical branch distribution network. This strategy is also easily reproduced however
online banks are limited to providing services that do not require a branch network.
HSBC, entered the market by purchasing the Bank of British Columbia in 1986.
HSBC however entered the market as a full service bank with both personal and
business product lines. HSBC also invested heavily in the business banking division
and presently, among domestic banks, it has a 12.5 percent share of the SME market up
from 3.4 percent in 1999.
12 ING Group, Press Release, Amsterdam, 20 October 1999
18
2.2.1.3 Low Likelihood of Retaliation to Market Entry
Given the close regulatory oversight of the Canadian banking system, it is
unlikely Canadian banks would engage in retaliatory practices in the event of new entry
to the market. in addition, since Canadian banks are perceived to wield excessive clout
domestically, if they were to engage in predatory behaviour, public opinion would quickly
turn against the incumbents and the Canadian government would likely intervene.
2.2.1.4 Economies of Scale
Banking is a low margin business, and as a result there are significant
economies of scale to be gained for small and medium sized banks. Some of these
economies of scale can only be realized through size, however many can be gained
through outsourcing back office and administrative functions. There are few, if any,
economies of scale to large banks becoming even larger. Studies show that size does
not correlate with cost reduction, but that banks find greater efficiencies when faced with
high competition as a result of dereg~lation.'~
Credit Unions, typically smaller players in SME financing have invested
significantly in back office centralization over the past 10 years in order to realize
economies of scale.
2.2.1.5 High Branding 1 Reputation Building Costs
Consumers entrust their savings, personal information, and their consumption
information to financial institutions. As a result, banks invest heavily in promoting an
image of trustworthiness and stability. Banks invest heavily in brand building through
advertising, branch design and community sponsorship.
l 3 Carbo Valverde, S., Humphrey, David B., and Rodriguez Fernandez, F. Bank deregulation is better than mergers. International Financial Markets, Institutions and Money. (2003). Vo1.13: 431
19
2.2.1.6 Mature Market Stifles Entry
The SME financing market is a mature market with an exp (J cted growth rate
between 5 percent and 7 percent.14 Any new entrant would have to gain market share at
the expense of incumbents. The aggressive pricing and advertising necessary to entice
customers to switch erodes margins.
2.2.1.7 Low Barriers to Entry
Although, economies of scale and high reputation building costs present
significant barriers to entry into the Canadian SME financing industry, there are many
foreign banks and large finance companies with the similar products and brand equity
who are not yet operating in the market. Companies such as ING Direct or GMAC could
use the economies of scale afforded by their personal lending businesses and their
recognized brand to enter the market. Witness HSBC's entry into the market in 1986
and its growth to 12 percent market share.
As well, the incumbents in the industry are under heavy government scrutiny, so
their ability to retaliate against a new entrant is very limited. The government is intent on
increasing competition in this industry and is reducing legislative and regulatory barriers
to entry. Finally, technology is allowing banking distribution to take place with lower
overhead costs and without having to employ bricks and mortar distribution, which
increases the potential scale of entry while reducing the capital outlay.
The Canadian SME financing market can expect more attempts to enter the
market. Given the success of HSBC and the lessons learned by Wells Fargo's failed
entry, in the medium term there is a high likelihood of new entrants.
14 Canada. Statistics Canada. Survey.
2.2.2 Suppliers
2.2.2.1 Shortage of employees with experience and training
Training for a new commercial financial analyst can take up to a year. Banks pay
for their employee training courses and on the job training is a significant cost. This
reliance on in house training and the lack of outside accreditations in the business-
lending field has increased the power of trained and experienced employees.
There are frequent instances where employees are poached from one financial
institution to another. This is an attempt to shift the risk of investing in employee training
from the acquiring institution to the one losing the employee; as well it is an attempt to
avoid the cost of training employees. Generally these employees are offered a 10
percent increase in pay to leave their current employer, which leads to an upward trend
in labour costs.
2.2.2.2 Information Technology Providers
Increasingly, banks are relying on third party suppliers for services such as digital
document storage, computer networks, telephone systems, transaction processing,
merchant services, credit scoring and ERP systems. These are fundamental business
functions and as a result the risks of the service providers can potentially impact the risk
to a bank. In most cases, these functions have been outsourced to take advantage of
economies of scale or to large investments in developing business functions, which are
not core competencies. As a result of these needs for economies of scale and the scale
of business transacted with a particular supplier, there are usually very few suppliers in
the market. The scarcity of alternative suppliers as well as the high switching costs for
these services, gives suppliers a degree of power over banks. The largest 5 Canadian
banks have resolved this, in some instance, by securing ownership in many of their
service suppliers, however smaller banks and credit unions have to find other solutions I
to mitigate supplier power.
2.2.2.3 Real Estate Scarcity
Most Canadian banks and credit unions rely on a retail branch distribution
network. Suitable real estate for branches is scarce, as the incumbents have already
established branches in the most suitable locations. As well, since banks require unique
leasehold improvements to accommodate large safes and sophisticated security
systems, landlords have the ability to extract long-term commitments and higher rents.
Finance companies often distribute their loan and lease financing through the
equipment vendors and vehicle dealerships. The finance companies are often affiliated
with the dealers. This reduces the cost of distribution, however since they do not have
direct contact with their customer the risks are greater.
2.2.2.4 High Availability of Capital
Large Canadian banks, insurance companies, and finance companies have high
capital availability both through equity markets, bond issues and securitization of assets
such as their mortgage and consumer credit portfolios. Smaller banks, due to poorer
credit ratings have slightly higher cost of funds. This can have a significant impact on
ROA since banking is a low margin business. Market forces do not set Credit Union cost
of funds. Members own shares of the credit union and receive a dividend at the
discretion of the Board of Directors. Except of Credit Unions, large banks benefit from
lower cost of funds and capital availability.
2.2.2.5 High Supplier Power
Suppliers to the Canadian banking industry, including SME lenders, have high
relative clout. Many have products and skills that are needed in the banking industry but
are transferable to other industries as well. Granted, the incumbents in the SME
financing market have high capital availability. The largest players are major Canadian
banks with billions of dollars in market capitalization and relative ease when raising
capital either in debt or equity markets.
This clout however is tempered by relative real estate scarcity. Banks depend on
branch distribution as their primary method of contact with customers, and the number of
suitable locations is limited. There are very few untapped markets and as a result when
a location does become available the landlords have greater leverage.
As well, once a bank has committed to certain IT and IS providers, the
relationship is necessarily long term. The banks may have clout during the bidding
process, however once a bank is running on a platform and the employees have been
trained to the platform the bank is dependent on that supplier.
Finally, a shortage of accredited, trained and experiences employees constantly
challenges the industry. Banks attempt to reduce turnover by providing high benefits,
profit sharing and stock purchase plans however turnover continues to be a challenge.
2.2.3 Customers Analysis
Relative to their lenders, SME borrowers are very small and diffused. There are
some associations of SMEs, such as the Canadian Chamber of Commerce and the
Retail Merchants Association, which have negotiated group pricing for merchant
services and insurance, however due to the risk characteristics unique to each SME
borrower these Associations have not negotiated group pricing for financing. The only
category that has negotiated group pricing for financing is franchises. Since franchisees
will each have similar risk profiles to one another and the group has a lower risk than
unbranded business, banks have been able to create uniform pricing packages for
franchises.
Traditionally, banks have segmented the SME market base,d on the amount of
authorized credit. Based on this criterion, there are three market segments in the SME
market. There are small enterprises with authorized credit under $500 thousand and
medium sized enterprises with authorized credit under $1 million. Micro businesses are
another segment usually with financing under the $25 to $99 thousand range, however
there is little consensus on the definition of this segment. Micro businesses are also
described as self-employed businesses or home-based businesses. Micro businesses15
comprise 39 percent of SMEs who borrow from domestic banks; Small enterprises16
comprise 52 percent while medium-sized enterprises make up the remaining 9 percent
of the market.
As per Figure 8, eighty-three percent of bank borrowers have credit
authorizations under $250,000~~, however 52 percent of funds authorized by domestic
banks are authorized for borrowers with limits over $250,000.
SME Authorizations
Figure 8: Authorization Sizes of SMEs Borrowing from Domestic ~anks' '
l 5 Borrowers with credit authorizations less than $1 00,000. l6 Borrowers with credit authorizations of $1 00,000 - $500,000. 17 Canada. Statistics Canada, Survey. 18 TD Bank Financial Group proprietary
Different regions of Canada have different industry focuses. As seen in Table 2,
the prairies have a strong agricultural sector. Quebec, Ontario, Alberta and BC all have
significant professional communities. Likewise they have the greatest concentrations of
knowledge-based industries.
Atlantic Provinces 6.6% 9.4% 5.1% 15.0% 7.5% 2.3% 54.2%
Quebec 9.7% 1.7% 7.1% 13.2% 10.8% 4.0% 53.4%
Ontario 8.5% 0.7% 5.6% 10.4% 12.5% 5.6% 56.7%
ManlSasklNunavut 44.8% 1.2% 3.0% 8.2% 4.3% 1.9% 36.7%
Table 2: SMEs' Sectors of Operations by Region in 2000'~
An Angus Reid survey of SMEs in 2000 found four perceived gaps in financing
service^.^' These gaps are size, risk, knowledge, and flexibility. SMEs often feel that
their financing requests are too small to gain the attention of banks and that banks are
more interested in larger volume deals. SMEs also believe that Canadian banks have a
very limited appetite for unsecured lending and are not willing to assume any risk. SMEs
in knowledge based feel that financial institutions do not understand their businesses
and that they are too quick to discount knowledge assets, such as patents, software and
the goodwill associated with an established brand. Finally, SMEs feel frustrated with the
lack of flexibility in what they believe is a "cookie cutter" approach to financing, where
standard ratios and credit scoring methods take precedence over common sense
business decisions. As much as possible, TDBFG's optimal strategy will attempt to
address these financing gaps.
l9 Canada. Industry Canada, Small and Medium-sized Enterprise (SME) Financing in Canada, Ottawa, 2002: 61 20 Angus Reid Group, Financing Services to Canadian Small and Medium Size Enterprises, July 2000: 19
2.2.3.1 Information asymmetry fading
ri Regulators are working in conjunction with institutions to e sure consumers are
adequately informed and protected by establishing disclosure rules and guidelines.*'
Transparency of information is critical given the history of information asymmetry
between consumers and institutions. Although many bank products are very similar,
they are presently presented in a way that makes inter bank comparisons difficult. For
example, a year ago the top five banks described interest rates on unsecured lines of
credit differently. Some tied the variable rate to the Prime rate and others tied it to their
Base rate. The Base rate is proprietary and not set by the market, and although it is
related to the Prime rate, different banks set their own Base rates. As a result of
government intervention, this practice has ended, however there are similar difficulties
when attempting to compare service charges at different institutions. As a result of
government regulated greater disclosure, customers are more informed and
sophisticated.
As demographics change, the average Canadian is becoming older and better
educated. As a result, they are becoming more knowledgeable and sophisticated in
evaluating their financial service providers. They are also becoming more comfortable
with alternatives distribution channels and service providers."
2.2.3.2 Product Homogeneity
Banking products are fairly homogeneous. This limited differentiation allows
customers to more easily compare between providers and reduced differentiation limits
banks' ability to charge higher margins.
2' The Financial Consumer Agency of Canada (FCAC) was founded in 2001 under the Financial Consumer Agency of Canada Act to consolidate and strengthen oversight of consumer protection measures in the federally regulated financial sector, and to expand consumer education. 22 McKinsey & Company, The Changing Landscape 25
26
2.2.3.3 Canadian Consumers Perceive Banks to Provide Little Value ~ d d e d ~ ~
The vast majority of Canadians are satisfied with the service provided by their
banks, however the number of dissatisfied customers is growing. Compared to other
service providers, when consumers were asked if the services provided were very good
or excellent, Canadian banks ranked lower than supermarkets and air travel but higher
than department stores and auto dealerships. If the satisfaction trends continue,
consumers will become increasingly open to alternative banking service providers.
2.2.3.4 Media and Regulators Trumpet Anti-Bank Rhetoric
Canadian media and regulators have increasingly echoed the rhetoric of special
interest consumer groups such as the Democracy Watch, Consumers' Association of
Canada and the People's Network on Banking, Credit and Capital. These groups focus
on the size and power of banks in the Canadian Competitive Analysis Chart of SME
Lending in Canadian economy and push for greater control and regulation of banks.
These groups also advocate nationalizing other industries to protect consumers from
profit seeking corporations. This type of media attention restricts banks to conservative
marketing and sales practices, which in turn reduce differentiation and increase
competition.
2.2.3.5 Increasingly Complex Underwriting Processes
With greater software sophistication and credit scoring systems, customers often
do not understand why they were approved, declined or why they must meet ongoing
financial conditions for leverage and cash flow. An Account Manager at a major
Canadian bank sells from a suite of over 20 debt product products and services in
addition to a multitude of deposit and cash management products. When customers are
presented with a huge product offering with varied bundled and un-bundled pricing
structures, they are more likely to purchase based on the advice of a bank employee,
23 McKinsey & Company, The Changing Landscape 67
27
rather than attempt to learn the product offering well enough to make their own informed
decision. This and the fact that consumers of bank services are not very price sensitive
gives banks some leverage in the producer-consumer relationship.
2.2.3.6 Lack of Buyer Concentration
Except merchant service agreements negotiated by trade associations and group
pricing for franchises, consumers of Canadian financial services do not form buying
groups to negotiate products and pricing with banks. There is a concentrated group of
financial service providers, each negotiating with individual SMEs on a one to one basis.
This again gives banks a distinct advantage in preserving fees and interest rate spreads.
2.2.3.7 Buyer Power is Low
Although public information on SME lending is improving, it is still not high. The SME
lending products are fairly homogeneous, however buyer concentration is very low and
customers are not aware of the high level of homogeneity. Customer price sensitivity is
low and on the whole customer power is low.
Even though buyer power is low, customer retention is still a real issue. Typically it costs
five times more sell to a new customer than cross sell that same product to an existing
customer.24 As a result of this TD Canada Trust has chosen to differentiate itself by
providing the most comfortable banking experience. This does not necessarily
contradict its low cost provider strategy, it is directed more toward the customer
experience and corporate culture. This strategy is similar to those of Walmart and
Westjet, which are both low cost producers but have nurtured customer centric cultures
that result in higher repeat business than their competitors. TD Canada Trust has been
recognized as an industry leader with one of the best managed brands in the financial
24 Deloitte. Global Banking Industry Outlook: 2004 Top Ten Issues.
28
services industry, preserving Canada Trust's reputation for strong customer service.25
Chris Armstrong, Chief Marketing Officer at TDBFG won Marketing's Marketer of the
Year for 2001.
2.2.4 Substitutes
SMEs find financing for their businesses from a variety of sources. Even though,
there are six banks that dominate the business loan market, there are other products to
consider. While Table 3 provides a broad perspective on the types of financing and
shows that individual SMEs source their financing needs from a variety of sources, it
does not provide an accurate picture of their share of SME liabilities.
Financing Instrument Percent of SMEs that use that Instrument Loans from Financial Institutions 49% Su~olier Credit 39% ~ e k o n a l Savings 35% Personal Credit Cards 33% Retained Earnings 31 % Business Credit Cards 26% Leasing 16% Personal Loans 14% Loans from friends and relatives 10% Government lending agencies 7% Angel investment 4%
Table 3: Sources of SME ~ i n a n c i n ~ ~ ~
Figure 9 shows the share of SME financing undertaken by each source.
loans from crown
lease obligations
loans from banks and loans from indiidu credit unions
35%
other liabilities 21 %
Figure 9: Breakdown of SME Liabilities by Type, 2 0 0 0 ~ ~
25 Woolstencroft, Timothy and Hanna, Jeannette. "The Best-managed Brands are about Delivering Customer Esperience" Marketing. 21 June 2004: 33. 26 Canadian Bankers Association, Cornpetion 6
29
2.2.4.1 High Threat from Alternate Distribution Channel
i Canadian Domestic Banks are under increasing pressure f om service providers
using alternative distributions channels. In 2001 ClBC created Amicus a division
responsible for operating non-CIBC branded electronic banking services. In the US,
Amicus offered personal banking in Safeways under the Safeway SELECT brand. In
Canada, Amicus operates President's Choice Financial out of Loblaws and it used to
offer business banking under bizsmart branding in Business Depot stores. There are
challenges related to chequing account and business current account services online
and in November 2002 ClBC began to wind up Safeway SELECT and other US
electronic Banking relationships, as these operations were not meeting financial
expectations. President's Choice Financial was expected to break even in 2003,
however CIBC's reporting for electronic bank operations is now combined with the
branch retail operations and figures for this division are no longer available. ING Direct
and Citizens Bank have both successfully entered the market using electronic
distribution by providing a simple suite of banking services and avoiding highly
transactional, fee based, chequing accounts. Wells Fargo made a failed attempt to enter
the market in 1999. The company has not provided much insight into why it exited the
Canadian market, however its pricing was not lower than the competition.
Mortgage Brokers also compete against traditional branch distribution,
sometimes obtaining greater rate discounts from Canadian Banks than their branch
networks are able to offer. Similar agency issues exist in equipment financing, where
banks have begun to offer car and truck loans though dealerships, in order to compete
against the incumbent finance companies, and these same loans are not offered through
the retail branches.
27 Canadian Bankers Association, Competition 6
30
2.2.4.2 Increased Competition from Monoline Providers
An increasing variety of single product businesses compete against Canadian
retail banks. In credit cards, MBNA, Capitalone, Citibank and American Express are
well established both in Canada and internationally. Other examples of niche players in
credit are, GMAC in car financing and the Business Development Bank, a Crown
Corporation. Factoring companies also fall under this category even though they have
found limited acceptance in the Canadian market.
In 1997 ING Direct began offering non-traditional savings accounts. American
Express followed ING in 1999 offering a similar savings account product with high
interest rates, no fees and no minimum balance requirements.
2.3 Value Chain Analysis The banking industry has a palindromic value chain with customers at both ends.
The deposit sold to one customer is pooled with other deposits and then re-packaged as
a loan product sold to another customer. In effect, a bank is an exchange broker
earning a commission spread between loan and deposit rates. We are limiting the
scope of this value chain analysis to the business lending product category, which, as
represented in Figure 10, is linear.
Der7~;;;nt> securities > Marketing > Distribution
Underwriting
Figure 10: SME Lending Value Chain
2.3.1.1 Product Development
Product development involves the creation and research of new financial
products and instruments. This group will design products and evaluate their potential
performance and profitability. This group delineates product definitions, term and
I conditions and evaluates the opportunities for bundling and the appropriate pricing limits.
If Product Development determines that the Bank cannot profitably produce a product
and they determine that the Bank needs to offer the product, they will refer the need to
outsource management. The business product group has made very limited use of
outsourcing.
When designing a product, product group must design with the entire product life
cycle in mind. 28 Using market research, Product Design at TDBFG looks for innovative
ways to redesign traditional banking products to make them more attractive to
customers. An example of this is the "cash back mortgage". A cash back mortgage is
booked at the market rate however the customer receives a percentage of the borrowed
amount as cash back on the mortgage. Another product is the "below prime mortgage"
which offer a rate below prime rate for the first 6 months and then reverts to regular
market rates. In both these instances the benefit to the customer is equivalent to less
than a 0.75 percent discount on the standard mortgage rates. These innovative
products allow the Bank to gain market share without competing on price, effectively
preserving bank margins. They also create a degree of differentiation for what would
otherwise be a commoditized product offering.
2.3.2 Securities Underwriting
Securities and risk management is the process by which bank assets are
classified by risk and matched with a bank liability of corresponding duration. As well,
instead of matching funds from deposits to loans, the Bank may securitize a loan
portfolio and sell it on the secondary market. Securitizing creates a pass through, such
as a mortgage-backed security, by which the pooled assets become standard securities
28 See Appendix A
backed by those assets and is exchanged for cash. The cash in turn increases the
Bank's liquidity and ability to extend more loans.
2.3.2.1 Securitization Design at TDBFG
Securitization is used to preserve the Bank's liquidity. For example, a portfolio of
similar risk mortgages is pooled and sold as an income product with similar
characteristics to a bond. When the instrument is sold, the Bank receives cash in return
for the sale of the assets. The Bank is then able to lend this cash to additional
borrowers. Securitization increases the efficiency of a key component of the multiplier
effect. Loans can be packaged as mortgage backed securities, banker's acceptances
and bonds, issued by the Bank.
2.3.3 Marketing
Marketing is responsible for market research, brand management, advertising,
and sales. Sales may involve sales support for a retail or branch network, or it may
involve direct sales via Internet or direct mail. Marketing will also support product sales
and development for broker and agent channels.
2.3.3.1 Marketing Analytics
The Bank regularly reviews its customer base to look for higher margin
opportunities. Recently marketing analysis has identified commercial and small
business banking, and insurance as high margin growth opportunities for the Bank.
Marketing also researches competing products in North America and around the world to
prepare the Bank for any potential threats.
2.3.3.2 Market Research
The Bank contracts out market research hiring a marketing agency, Harrod &
MirlinIFCB, to conduct surveys and customer focus groups. The Bank also conducts
data mining to support its telemarketing and direct mail efforts.
2.3.3.3 Advertising
The Bank's advertising is split amongst newspaper, radio, A7 agazine, online and
interior transit advertising. Print ads also run in newspapers across the country, including
the Globe and Mail, Toronto Star and National Post, as well as in national consumer and
business magazines. The primary purpose of advertising is to communicate the Bank's
value proposition and positioning as the most comfortable bank to deal with.
2.3.4 Distribution
Distribution represents the contact point with the consumer. In the banking
industry products may be offered through a wide variety of distribution channels.
2.3.4.1 Bank Branch
The majority of Canadian banking services are sold through bank branches.
These are fixed retail locations owned by chartered banks, trust or credit unions. These
retail operations carry a full suite of business lending products.
At TDBFG the retail branch network is considered the most stable source of cash
flow for the Bank. The branch network's primary function is sales of products and
services. The Bank has recently focused the attention of the branch networks on the
higher valued customers. The cost of the branch network is very high, and to the
network to run efficiently employees must add value with the majority of customer
interactions. It is recognized by marketing that 2 percent of customers generate 98
percent of the Banks profits. The Bank is focussing on this highly valued 2 percent of
customers and seeking ways to increase their market penetrations.
The branch is divided into two functions, sales and service. Sales employees
deal in lending and investments whereas service employees deal in day-to-day
transactional banking and sales support. Sales staff is evaluated primarily on sales
revenue generation and service staff is evaluated based on customer service
satisfaction.
Cross Selling Systems
Cross selling systems are considered a key driver to fully leveraging the benefits
of the TD Bank and Canada Trust Merger. Using the following systems, the Bank hopes
to earn greater economies of scope.
Economies of scope occur when the Bank achieves cost savings by increasing
the variety of goods and services that it produces (joint production). Such effects arise
when it is possible to share inputs and to use the same facilities and personnel to
produce several products. For example, the Bank may sell creditor insurance with its
mortgages in its local branches in order to spread the fixed costs (like the office rent)
over a larger number of products.
RadarILeads
Radar Leads is a basic data mining system that cross references customer
demographics with their current product set with the Bank and determines what products
the customer may be interested in buying. The next time the customer visits the branch
to make a transaction, a lead is triggered and the employee is prompted to initiate a
conversation about the target product. This system is designed to increase customer
product penetration, which will in turn lead to greater market share and higher
profitability for each customer relationship.
TD Leads also has the ability to create referrals to other Bank Division with a
consistent referral mechanism for achieving economies of scope. Even though different
business units use different software platforms, the web based referral system is
accessible from every unit in the Bank and allows consistent communication and
tracking of referrals between different business units.
2.3.4.2 Retail Stores
Retail stores such as Staples and Home Depot offer in-ho e credit to business
customers. Staples bizsmart, was a re-branded product line produced by Amicus Bank,
a ClBC subsidiary. ClBC has since discontinued this relationship with Staples.
Apparently the relationship was not profitable.
TDBFG recently disengaged itself from a partnership with Walmart after the US
government declined its request to expand in-store branches into the United States.
2.3.4.3 Brokers & Agents
In the business lending market, brokers and agents primarily offer property
secured business mortgages. Unlike bank branches, brokers will source their products
from a variety of financial institutions and will receive compensation from these
companies based on the volume and pricing negotiated on a product. Brokers can sell
the same products that may be available in branches and are often a source of channel
conflict. Other Agents sell banking products as well. Car dealerships offer loan
financing underwritten by several banks depending on the purchaser's preferences.
TDBFG has several products including mutual funds and mortgages that are sold
through brokers and agents. The Bank has regional marketing support offices that are in
continual contact with brokers and agents supporting them with information and support
for selling the Bank's products. Business loans are not one of the products sold through
the broker agent channel.
2.3.4.4 lnternet & Telephone
The lnternet has allowed Chartered Banks to offer their full product line over the
lnternet and telephone. As well, several credit card companies post links to applications
for their business credit cards online.
TDBFG employs a department called e.Bank whose purpose is to generate sales
through non-branch channels. This includes online adds, telemarketing and direct mail.
This channel competes directly with retail branch network, however the Bank recognized
that competitors market to customers in the same fashion. The Bank feels that
cannibalising customers from the retail channel is better than losing customers to
competitors.
2.3.4.5 Direct Mail
Many monoline finance companies sell products using direct mail. Most often
credit cards are sold in this fashion. Banks often offer businesses term loans via direct
mail offers.
2.3.5 Loan Production & Credit Management
A unique characteristic of production in lending is that the product is customized
and production begins after the first contact with the customer. The customer first
applies for a loan, the Bank produces an offer that the customer in turn accepts or
rejects. At this point, the Bank has already expended resources and time, but has no
guarantee that the customer will purchase the product. If the customer accepts, then the
Bank produces documentation, which the customer signs at the next meeting after which
the loan is funded. The process can be fairly costly.
2.3.5.1 Credit Management
At TDBFG, Credit Management provides effective risk management for the loan
portfolio within quality guidelines while acting as an advisor through ongoing
communication and sharing of information with the distributions network. Credit
Management has a mandate to provide approvals or suggested alternatives in a timely
manner and assist in the developing the distribution channels and their ability to
understand credit decisions.
Credit Management's primary responsibility is to protect the Bank's assets and
ensure consistent application of the Bank's lending policies. A key lesponsibility is to
maintain the loan portfolio within established quality guidelines. Through ongoing
dialogue Credit Management provides coaching and guidance to branch staff in
structuring new and existing deals, adjudicate loans, monitor branch performance and
participate in setting up new policies, procedures and systems. The Bank considers its
Credit Management processes and systems to be superior in providing quality decisions
at the lowest cost. The Bank uses a combination of automated approvals and
underwriter review. Deals rejected by the automated system are forwarded to an
underwriter for review. Credit Management is a cost centre and is a great contributor to
bank efficiency though its ability to provide quality decisions and credit reviews at a low
cost to the organization. The Bank has licensed automated decision making software to
process approvals on more straightforward deals so that high paid underwriters can
focus on deals which require greater analytical ability. This area is also considered a
contributor to cost efficiency for the Bank.
2.3.5.2 Credit Administration
Credit Administration, at TDBFG, handles all support activities related to the
Bank's credit portfolio. These are divided into Loan Accounting, Non-Negotiable
Security, Compliance Functions, Mortgage Administration, In-House Legal and
Commercial Banking.
Loan Accounting handles the data input and disbursement of funds for
unsecured, secured and small business credit. The Non-Negotiable Security
department prepares all legal documents and forms, related to credit products, and
sends them to the originator of the loan. Compliance verifies executed documentation
and rejects documents with errors and omissions. Compliance is also responsible for
monitoring margined security, registering government guaranteed loans, administering
renewals and issuing letters of guarantee. Mortgage Administration handles all aspects
of a mortgage after the documents have been signed and the mortgage registered. This
involves verification of documentation, discharges, tax reporting and monitoring of
arrears. In-house Legal is a service provided by the Bank to customers, which can
provide collateral mortgage charges at a pre-negotiated low price. This reduces the cost
of legal service to the customer, but also allows the Bank to waive legal fees for
promotion and campaigns. Finally, Commerial banking provides credit administration
services for all aspects of the Bank's commercial loan portfolio. This is considered a
cost centre and linked to the Bank's core competency.
2.3.6 Service
Service is provided through four channels: branches, retail location, Internet and
telephone help lines.
2.3.6.1 Customer Service Indexing
CSI is a scorecard based on customer surveys measuring their perception of
service from the Bank. The questions asked are based on the Voice of the Customer
(VOC) research, a survey of consumers of all financial institutions in Canada. The
research from VOC reveals what is important to customers when choosing a financial
institution and, for the most part, their choice is based on how well they were served in
the course of an interaction with staff.
Some of the attributes of a satisfactory service interaction are:
Using a proper greeting (e.g., "Good MorningJAfternoon, how may I help
you?").
Introducing yourself by name.
Smiling at your customer.
Establishing eye contact with your customer.
Wearing your legible name tag.
Listening to your customer's request.
Confirminglrestating the details of your customer's request.
Asking your customer questions about their needs.
Giving your customer advice or making recommendations based on their
needs.
Treating your customers with respect.
These attributes give the customer the perception that we know who they are,
they have our undivided attention and we appreciate their business. Overall these
attribute give the perception of a comfortable banking experience.
2.3.6.2 EasyLine
EasyLine allows customers to conduct day-to-day banking over the phone using
both an automate service as well as with customer service representatives. They also
have access to apply for credit and investment products as well as executing mutual
fund transactions.
2.3.6.3 Customer Cares
The Bank aims to provide a premium level of service, however it recognizes that
service issues will arise in the normal course of business. To ensure that the Bank is
doing its utmost to provide the highest level of service the Bank has created the
Customer Problem Resolution (CPR) Process. This process also recognizes that
customers whose complaints are dealt with quickly can become some of the most loyal
customers to the Bank. The customer problem resolution process is the Bank's way of
ensuring that client problems or concerns are addressed in a consistent way. Most
customer concerns are successfully resolved at the branch or business area level. The
CPR is also built on the premise that the customer should only have to explain hislher
problem once, and that from then on TD staff will relate the issue to one another if it is
escalated to a senior officer in the branch, district or ultimately the Ombudsman. An
issue is escalated if clients are not satisfied with the solution presented by the front line
staff, at this point the Manager or Business Unit Leader will become involved and will
attempt to resolve the situation. If the client is not satisfied with the solution received
from the first level, Manager or Business Unit Leader, then the Manager will offer to
elevate the problem, communicating all relevant details on the client's behalf, to a
representative of the Senior Management Officer responsible for the branch or business
unit. Problems escalated to senior management negatively impact the branch
scorecard. Alternatively, if the client prefers to elevate the problem him or herself, the
Manager will provide contact information for a Senior Management Officer. If the
problem or concern remains unresolved after branch manager and district manager have
attempted to settle the issue, the client may contact the TD Ombudsman.
2.4 Competitive Analysis The immediate competition to the TDGBF consists of the four other large domestic
banks and the credit unions. This is a mature market where market share gains are
primarily made at the expense of the competition. As per Table 4, Royal Bank and Bank
of Montreal hold the highest market shares, together holding almost fifty percent of bank
loans to the SME market.
Category I ClBC 1 BMO
SBB
Definition
# of Customers 470,000 438,000
Market Share 14.4% 22.2% SME Lending
<$5MM sales
<$I MM credit needs
Market Share 16.2% Total Assets
<$5MM credit needs
Distribution Model
RBC 1 BNS 1 TDCT
1,300 small business advisors in branches
<$I MM credit needs
Account managers reside in branches
1,200 business bankers
<$I MM sales
<$250M credit needs
600 SBB All branch Account Mgrs salespeople and SBB I00 SBAs with resources little SBB focus centre !
<$I MM sales
<$250M credit needs
Table 4: Analysis of small business banking at the 5 largest Canadian banks2'
In Small Business Banking, Canadian Banks are divided into specialists and
generalists; Bank of Nova Scotia has a blend of both tactics. It is worth noting that
TDBFG has separated small enterprises from medium enterprises, all other banks save
BNS have not, and use the same distribution channels to service both sub-segments of
the SME market. TDBFG has intentionally differentiated itself, and this has earned it
great success in micro lending under $25,000, Figure 11 reveals good results in credit
ranges under $250 thousand but relatively poor market share results from $250
thousand to $500 thousand and very poor results from $500 thousand up to $1 million.
At first glance, it would appear that the generalist approach is sufficient for credits with
low sophistication, however deals requiring greater expertise require SME specialists to
be in contact with the customer.
*' Source: Small Business Product Group
RBC
ClBC
&i TDCT
BNS
BMO
HSBC
Figure 11: SME lending market share statistics
Royal Bank is the market leader in SME lending and has historically done well
leveraging its large personal customer base to gain market share in business lending. It
has a similar strategy to TD Canada Trust's personal banking, focusing on the customer
experience with a focus on employee responsivene~s.~~ From a positioning standpoint,
RBC positions its brand to represent trusted banking professionals, whereas TD Canada
Trust positions itself as the friendly neighbourhood bank. Bank of Montreal and HSBC
are stronger in the higher credit ranges, but lag in the small business segment. BMO is
focused on process improvements and lags RBC and TDCT in brand re~ognition.~' The
Bank still has significant growth potential in the small business segment and has very
considerable opportunities in the medium enterprise segment.
30 Royal Bank of Canadai 2003 Annual Report. 31 Bank of Montreal. 186' Annual Report 2003.
2.4.1 Competitive Concentration is high
Competitive concentration is high in the debt financing mar i et. There are five
domestic banks and one foreign bank that dominate the Canadian banking landscape,
and generally these players try to avoid competition on price alone. The retail banking
industry has a balanced mix of competitors. Apart from large banks there are medium
and small sized banks and credit unions.
2.4.2 Increased Competitive Pressure from Mature Market.
The Canadian banking industry is a mature market with an expected growth rate
between 5 percent and 7 percent. Existing firms compete for market share at the
expense of competitors. Market share gained using aggressive pricing, loose credit
policy, high service levels and marketing. The costs of these tactics tend to erode bank
margins.
All Canadian banks are investing in cross sell technology, to identify sales
opportunities. This is in recognition that the additional revenues gained from cross
selling existing customers, has a lower cost of production than revenues derived from
new customers.
2.4.3 Commoditization of Banking Products and Services
Government regulation and online banking has increased the transparency and
comparability of banking products. There is very little differentiation between the product
offerings of different banks. Both borrowing and investment products are fairly
homogeneous. This limited differentiation creates competitive pressures in the market.
Banks have attempted to counteract the competitive effects of a homogeneous
product line by developing stronger brands and differentiating their service delivery.
These efforts and a renewed focus on relationship selling have met with mixed success.
As mentioned earlier, TD Canada Trust has successfully combined the low cost
sales culture of the pre-merger TD Bank and service culture of Canada Trust. The Bank
is using its reputation for exceptional service to differentiate its product distribution.
Even though the products are homogenous, product delivery can be differentiated
without sacrificing cost effectiveness and productivity. The service culture is well
entrenched in the personal banking business which ranks second to the Royal Bank in
market share. The culture is not well entrenched in the Commerial bank. The
Commerial bank market share ranks in fifth. This is partly a product of history, since
Canada Trust did not have a large business portfolio when it merged with TD Bank, as a
result, the merger augmented the retail book but left the commercial book relatively
unchanged.
2.4.4 Technology Enables the Easy Switch
Regulation and technology have enabled banks to switch customers from
competitors more easily. Using the inter-bank clearing system, banks can ensure your
cheques from a former bank service supplier will be re-routed to the new bank account.
A majority of Canadian banks have contracted out account switching services to
Davis & Henderson. Davis & Henderson is the dominant supplier of micro-encoded
cheque printing services and has close ties to most major Canadian banks. As
switching banks becomes easier, and account acquisition tactics will necessarily lead to
higher churn rates, which reduces bank margins on product acquisition, but leads to
healthy revenue growth for Davis & Henderson. The resulting reduction in switching
costs places increased competitive pressure on industry players.
2.4.5 High fixed assets costs
Banks have high fixed costs for the branch network and sunk costs for setting up
business systems. This increases rivalry because the marginal costs of an additional
product sale are low. As well, increased capacity from opening a new branch results in I
aggressive customer acquisition tactics in order to build sufficient1 J large revenue
generating customer base to cover the branch's fixed costs. TD Canada Trust has
slowly divested itself of most of is fixed real estate, opting for long term leases rather
than tying up capital in real estate.
2.4.6 Brand Equity Costs and Political Barriers to Exit
Canadian Financial Institutions carry a portfolio of businesses and most banks
share common branding across their business units. As a result, exit from one business
segment or geographic area signals a bank weakness and gives the appearance of lack
of concern for community access that can reflect negatively on other business units.
This negative perception of the group brand weakens the group brand equity.
As well, exit from a particular business or geographic segment usually entails
branch and office closures, as well as layoffs. Since banks are significant employers in
the Canadian economy, it is not unusual for government to intervene or enter into
discussions with a bank to maintain employment and access to banking services to
Canadian consumers.
2.5 Key Success Factors Succeeding in the SME lending market hinges on the following key success
factors.
2.5.1 Culture
Culture is a powerful tool for people development, and strong consistent culture
in a large bank like TDBFG can be a sustainable competitive advantage. This is because
it is difficult to change the culture in a large organization and as a result a successful
culture is difficult to duplicate.
The Bank must develop a customer focused culture, which rewards business
development and encourages lenders to lend freely within guidelines. Relationship
managers should be readily available to their customers and deliver consistently
comfortable customer experience with full transparency to the financing process. The
amount of time spent in contact with customers and prospective customers should be
maximized.
Business lenders have traditionally been hired and rewarded for their analytical
skills rather than sales and business development ability. As well, lenders within TDBFG
serving medium sized businesses that have underwritten deals that subsequently go bad
are penalized, even if the fundamentals of the deal at the time of approval were sound.
This leads to overly risk adverse behaviour. The culture within the Small Business
lending group is not uniform. There is a mix of sales oriented Small Business Advisors
as well as others who are more reactive. TD Canada Trust is recognized for its strong
service culture in its personal banking business, and it has preserved the sales focus
inherited from TD Bank. The Bank needs to map this culture to the SME Banking
Group. Since there are relatively few SME relationship managers at this time, the
process of culture change will be easier than for TDBFG's competitors.
2.5.2 Marketing
Individual campaigns and product specific advertising will meet with limited
success unless they are part of a coordinated marketing plan directed at the SME
market and its sub-segments. To gain marketing momentum, the Bank must present a
consistent identity to the SME market. It must also develop seamless relationship
management between small enterprise and medium enterprise lending.
Presently, medium enterprises are served by the commercial bank and the
personal bank and Small Business Banking Group share responsibility for small
enterprises. The commercial bank spends limited funds on marketing and small
business lending is only one of many products offered by the personal bank. TD
Canada Trust has excellent brand recognition in the personal market, however SME
customers are not aware that that same brand image applies to their market as well.
The Bank needs to direct a similar brand consistent marketing program toward this
market segment to increase awareness.
2.5.3 Sales & Distribution
Distribution should be focussed on the target market and should be seamless
and transparent to the customer. As well, SME customers repeatedly communicated to
the banking community that they would like relationship managers with sufficient
expertise to handle their relationships.
Presently, the Bank has two separate bricks and mortar distribution channels for
business banking. The retail branches with their Financial Advisors and Small Business
Advisors serve the micro business and small enterprise market. A sales support team
provides retail branches with training and advice.
The commercial banking hubs serve the medium enterprises, mid-market and
junior corporate. Micro businesses are also sold products via direct mail and telephone
marketing.
There is no clear focus or accountability for sales and distribution to the SME
market. The reporting structure for the people in the retail branches culminates at the
regional level, the small business sales and support group report nationally, and the
medium enterprise group reports to a regions, which do not match the retail bank
regions. At the branch level, managers are rewarded for meeting revenue and volume
targets regardless of whether these are met selling personal or business products.
Similarly, the commercial bank's performance includes revenue and volume from
medium enterprises, mid-market and junior corporate, the smallest of these being
medium enterprises.
There are approximately 100 business specialist in direct contact with small
enterprises. RBC and ClBC have 1200 and 1300 respectively. Assuming they have
traditional SME lending cultures, these specialists spend less than half their time in
direct contact with the customer and are otherwise occupied with renewal and
maintenance tasks. These tasks provide less value to the Bank than a relationship
building meeting devoted to understanding the customers' banking needs and selling
additional services. Once again the SME Banking Group can learn lessons from the
more competitive personal banking market. The SME Banking Group will need to
increase the number of relationship managers and locate them closer to the business
customers. The personal banking group has superior sales skills and these skills must
be instilled in the expanded SME Banking Group. Processes must be improved to
reduce administrative duties for SME Bankers and ensure they spend their time
engaged in activities which provide the greatest value added to the Bank.
2.5.4 Systems and Processes
Systems and processes should be aligned with the business culture and
reinforce the value creating activities.
At TDBFG, loan approvals for micro loans can be instantaneous, however SME
loan approvals can take anywhere from 4 hours to a week. In the case of small
enterprise loans, this process may take longer depending on the expertise of the
employee in contact with the customer. As well, approval for merchant services must
be obtained separately from loan approvals. A customer, who grows from a small
enterprise to a medium enterprise and as a result is transferred from the personal bank
to the commercial bank, must be re-approved for their credit facilities and vice versa.
49
TDBFG's aim is to provide product fulfilment at first point of contact. Processes should
be implemented to support this goal. Customer credit information i n d relationship
management Information should be scaleable and transferable between market
segments and business units. IT should also enable the organization to maximize the
benefits of credit scoring and reduce process costs of approval and credit review.
Cross selling business products to existing personal customers is a great
opportunity for financial institutions. This especially holds true for TDBFG whose market
share in personal product is more than double its market share in the SME market.
TDBFG must identify SME cross sell opportunities among TDBFG's personal customers
and existing non-borrowing SME customers, and leverage these relationshipd to gain
market share.
2.5.5 Credit Policy & Risk Management
To succeed in SME lending, a bank must balance sales growth against risk
management. Credit policy should require only the due diligence necessary for the loan
decision. Risk Management should be equally accountable for fast turnaround of credit
decisions as for controlling risk, and the credit process must be transparent and
consistent to the customer.
The small business lending credit group is tracked on turnaround and approval
statistics, however the medium enterprise lending group risk management (GRM) is less
accountable. This one group reviews deals anywhere from $250 thousand to $50
million. Understandably this group cannot be expected to spend a similar amount of
time on every deal.
2.6 The Current Strategy TDBFG's current strategy to address the small business market is a low cost
producer strategy. The company has made ongoing efforts to reduce production costs
and has made only limited investments in new product development. Instead of
expending resources on new product development, the Bank has utilized strategic
partners to expand its product line. The medium enterprise segment is served
differently. The commercial bank has raised prices to preserve margins, but has not
significantly reduced cost of production. This has created friction when customers are
transferred from small business banking to medium enterprise banking, because
increases in credit requirements result in a jump in interest rates and fees.
The Bank has taken steps to reduce cost structure for deals in the $250,000 to
$500,000 range by scaling down the existing Domestic Commercial Credit Review
(DCCR). The revised DCCR requires less detailed analysis and allows faster
completion of credit requests. This is accompanied with reduced pricing for this market
segment, however its pricing in this market is not low relative to the competition. Under
the current strategy the Bank can expect to gain market share in micro lending, but
continue to lose ground in small and medium enterprise lending.
2.7 Core Strategy TDBFG has one primary strategy in the business lending area. This involves
building shareholder value by maintaining a core competency as the low cost supplier,
preserving margins with low production costs.32
However given that the Bank's intended goal is market penetration in the short to
medium term, the current strategy alone will not result in the intended outcome. As well,
given that SMEs are not particularly price sensitive, offering a low cost, no frills service is
unlikely to result in a dominant market share.
As well, the authority and structure of the business units involved in SME lending
are not centralized, yet to remain consistent in the low cost strategy a more focused
32 Porter, Michael E. Competitive Strategy, 1980
51
reporting structure is in order. TDBFG must find a strategy, which will preserve its low
cost production but allows the Bank to outperform the competition in the acquisition and
retention of SME borrowers.
In order to gain SME market share the Bank must engage in a rapid penetration
strategy. This paper presents two distinct alternatives, depending on the Bank's
capabilities and commitment.
2.8 Optimal Rapid Penetration Strategy In order to gain market share in the SME lending industry TDBFG should adopt a
rapid penetration strategy based on providing greater value while matching the lower
range of the competition's prices. This is in line with the personal bank strategy and the
TD Canada Trust brand. As well price demand is relatively inelastic, therefore lower
prices may result in some market share gains but they would be at the expense of net
income. This would also attract the sub-segment of this market that is price sensitive
and if prices were subsequently raised, these customers would leave the Bank.
Customers do value a comfortable banking experience and since delivering that
experience is not easy to duplicate, this is a sustainable strategy for the SME Banking
Group. The benefit of this strategy is that the sales and service culture is more difficult
to duplicate in SME banking, because the TDBFG's competitors have incumbent
administration and analytics focused cultures serving that market segment. The
customer experience strategy will be supported by market development and product
development. The profitability of these strategies will be preserved as a result of
TDBFG's protection and enhancement of its core competency as a low cost producer.
A portfolio of tactics will support the comfortable banking experience. These
include creating a customer centric sales force focused on the SME market segment that
will manage the customer relationships. The bank will engage in process improvements
to increase the speed and transparency with which financing requests are processed.
The Bank would launch a strong advertising and promotion campaign targeted at the
SME market to increase awareness of the TD Canada Trust value proposition. This
strategy will win customers from TDBFG's competitors and increase existing SME
retention. Finally, development of the SME market will be achieved by cross selling
SME banking services to existing personal customers who are also business owners,
while product development will focus on asset lending.
The combination of these strategies should result in rapid annual market share
gains in the medium term with continuous product development.
2.8.1 Culture
TD Canada Trust has a strong sales and service culture, whereas TD
Commercial Bank has stronger roots in analytics. In order to create a culture based
sustainable competitive advantage in SME lending, TDBFG should create a customer
centric culture in all business units involved in SME banking.
Similar to the personal bank, the business banking area needs to deliver a
consistently comfortable customer experience. This is the Bank's primary differentiator
and its most powerful tool for gaining new business without using tactics that reduce
margins.
2.8.2 Marketing
TDBFG has an enviable marketing machine, which is credited with the
development of the TD Canada Trust brand. TD Canada Trust brand has strong
recognition for personal banking, however it is not strongly associated with business
banking. Once the SME Banking Group is capable of delivering the brand promise, the
Bank should expand the brand to represent SME banking too. Then the Bank should
continue to build the brand through advertising and consistently delivering the brand
proposition, "a comfortable banking experience". Marketing will also investigate
appropriate job titles for SME Bankers based on market research and focus group
research to ensure the titles support the sales environment, culture and image of TD
Canada Trust.
2.8.3 Sales & Distribution
The optimal strategy has a significant impact on distribution. It involves dramatic
changes to structure, performance measurement, and compensation.
2.8.3.1 Structure
In order to reduce distribution costs the SME business at TDBFG should adopt a
simpler organization structure as well as a more aggressive compensation structure. As
per Table 5, the Bank needs to be strict in its focus on the market segment.
Loan authorizations under $1 00,000
Day-to-Day business banking needs
Loan authorization greater than $1 00,000 and less than $1,000,000
Deposit & investment balances greater than $250,000 and less than $1,000,000
Cash management services
Loan authorization greater than $1,000,000
Deposit & investment balances greater $1,000,000
Cash management services
Table 5: Business Segmentation under Optimal Strategy
The Personal Bank will serve micro lending needs and customers with
straightforward business banking, however customers will have a business banking
hotline where they can receive business services over the phone, from a group of
telephone agents specialized in business banking.
TD Canada Trust SME Banking would serve more than just borrowing
customers. The focus is on the SME market segment and the relationship manager
should manage all products that would serve that market segment. SME bankers should
be located in retail branches in geographic proximity to their customer portfolio. If there
were a concentration of customers in one area then several SME bankers would be
assigned to the branch. Career progression in SME banking would relate to the
composition of each portfolio of 100 to 200 customers. A SME banker would begin with
a portfolio of small businesses and would progress based on his or her portfolio size. As
the SME Banker's portfolio grows in size and complexity the number of relationships
served would decline. This means that a new SME Banker would have a portfolio of 150
to 200 customers with small credit limits and an experienced SME Banker would have a
portfolio of 100 customers with limits in the $750 thousand to $1 million. The portfolios
would be rebalanced semi-annually, with smaller relationships referred to junior
portfolios. There would be no restrictions on the size of new acquisitions. If a new SME
Banker brings in a $1 million client, she will book the deal and keep the relationship. If
she requires assistance in structuring and submitting the deal, this will be provided by
her manager, however she keeps the relationship.
The corporate reporting structure would also be streamlined. SME bankers
would report to district managers who in turn report to one of 9 regional Vice Presidents
who then report to the Senior Vice President for SME an king.^^ The regions should
perfectly overlap the 9 personal bank regions and the districts would overlap the 54
personal bank districts.
33 Appendix B
2.8.3.2 Focus on Small and Medium Enterprises
In order to gain market share in the targeted SME market $3 gment, TDBFG must
ensure that the group serving this market segment is focused on the market segment
alone. SME bankers would no longer report to retail branch managers who are
responsible for a portfolio of over 200 products and various market segments. SME
bankers will report to a District Manager of SME Banking.
SME Bankers will be rewarded for referring business to other businesses of the
Bank, however they will not be rewarded for selling products targeted at other market
segments. Other business units will also be rewarded for referring business to the SME
Bankers.
2.8.3.3 Compensation
SME bankers at TDBFG would have lower salaries but higher performance
bonuses than the industry average. The structure would still match average
performance to the average market compensation, however TDBFG would have a
greater emphasis on performance. Bonuses would be tied primarily to new business
acquisition and would be modified by a customer service multiplier based on a Business
Sales CSI as well as a volume growth mu~tipl ier.~~ This compensation structure would
not necessarily lower distribution costs, but it would preserve margins, the culture, and
the brand.
2.8.4 Systems and Processes
Systems and processes need to be aligned to the culture and business strategy.
This requires modifications to existing Customer Relationship Management systems,
34 New business refers to bringing a new customer to the bank and includes cross-selling a SME product to an existing personal banking customer or business customer who presently has no SME products.
investment in Credit Scoring technology, investment in Credit Management systems and
moving some processes offshore.
2.8.4.1 Customer Relationship Management (CRM)
Current CRM systems result in costly duplication. Presently the relationship
manager inputs the credit information into the CRM system, however the adjudicator
prints out this information and re-enters it into a credit adjudication system, which is used
to track and approve the credit. The level of automation is fairly low. If the customer
were to request approval for merchant services, a non-credit product, the relationship
manager would have to prepare a separate application in paper format and fax it to the
merchant services department where the information would once again be re-copied
onto a paper based adjudication form. As well, if small business customers graduate to
the medium enterprise segment, the relationship manager must complete a new
application to approve the customer under medium business guidelines. TDBFG must
develop an enterprise wide system for gathering information about business customers.
The system should be scaleable and allow for the differences in due diligence required
for different types of requests. Different departments may access this information to
make their decisions. Ideally the credit platforms will pull needed information off of the
relationship management system. Finally, in order to maintain high service levels and
process transparency to the customer, the system should allow the customer to know
the status of their request at any point in time by login into the internet banking site and
clicking on "credit application status".35 Dell Computers and Amazon.com have
pioneered this type of order tracking technology.
For the Bank to take advantage of its higher market share in personal banking,
any customer relationship management (CRM) system must be tied to, or an extension
35 See Appendix C
of, the personal CRM system. The personal CRM system not only, maintains customer
information and assists employees in the sales process, it also feeds data directly into
the credit application system. The Bank should increase the scope and functionality of
this system to handle SME customers.
2.8.4.2 Credit Scoring Technology
Developing credit-scoring technology in-house would be a high risk and costly
endeavour. In the short run, TDBFG will have to purchase credit-scoring technology and
customize it to reflect its low cost objectives. Given that this technology will likely be a
long-term key driver of production cost, TDBFG should investigate the acquisition of a
credit-scoring technology provider or a foreign bank with a superior platform in order to
gain control of the technology and future enhancements.
2.8.4.3 Credit Management Technology
As a result of levels of low automation in Credit Management Technology for
small business credit, in 1999 the Bank consolidated several regional credit centres into
two centres that serve all of Canada. Consensus in the industry indicates that local
knowledge increases the quality of credit decisions made. As the credit process
becomes more automated and customer information is stored electronically rather than
paper files, the Bank will have the opportunity to pilot satellite credit centres. These
would be small credit offices with as few as 10 underwriters located in high volume
areas. As a result of automation, they could handle deals from outside their area if they
are below capacity and could hand off deals to other centres if they are over capacity. It
would ensure that deals that make good business sense in a local context would be
approved without increasing production costs to the Bank. The current large centres are
located in Edmonton and Markham and could have satellite offices in smaller urban
centres around the country. The decision to locate a centre would be dependent on the
volume of credit requests received from that area.
2.8.4.4 Cross selling personal and existing non-borrowing customers
The Bank has existing cross sell technology, which is presently being used to sell
additional products existing TD Canada Trust customer^.^^ This technology has been
used to target micro businesses and to a lesser extent small businesses, however it has
not been used in a focused manner to target the SME market.
This technology would be used by the SME banking teams to identify prospective
customers with a high likelihood of needing SME banking products and a high likelihood
of being approved for credit products.
2.8.4.5 Outsourcing or Offshoring
Throughout the application, adjudication, loan production and subsequent
monitoring of SME borrowers, there is a great deal data inputting and administrative
work, which can be performed remotely. In order to reduce cost of delivery and provide
personalized service to smaller customers, the Bank should explore using offshore and
outsourced services. For example, financial statement analysis generally involves
transferring the information from the customer's financial statements into a software
package, which then produces the ratios and figures necessary for a credit decision.
This data input process could be handled at a remote site. The documents would be
faxed to the site along with any comments needed to clarify ambiguity. The data input
would take place off site. Likewise with monitoring of inventory, accounts receivable and
accounts payable. These reports could be faxed directly to the remote site.
Citigroup presently runs call centres and processing centres in India and has had
a presence there for years. American Express, ABN AMRO and HSBC have all set up
36 Leads & RADAR
operations in India as well. Offshoring not only results in lower costs, but also 2417 I
operational capabilities. Documentation for SME credits could be prepared at a remote
location and sent to the relationship manager as an Adobe Acrobat file to be printed and
signed by the customer. Presently, documentation preparation can take up to two days.
There are operational and reputation risks to shifting operations offshore,
however, as evidenced by the number of banks already engaged in this activity, these
risks are manageable. Current trends suggest that use of offshore capabilities will be
necessary simply to maintain the Bank's low cost leadership.
2.8.5 Credit Policy & Risk Management
In order to gain market share, the Bank should develop products that SME
borrowers use, but that have traditionally been outside the banks' credit guidelines.
2.8.5.1 Asset Lending
The one product area that presents the greatest opportunity is asset lending.
Considered higher risk by banks, because of its reduced reliance on historical cash flow,
asset lending has been profitable for other financial institutions including some smaller
Canadian banks. Asset lending focuses on four types of assets: Inventory, Accounts
Receivable, Equipment and Land & Buildings.
TDBFG should develop products targeted at financing these assets or purchase
businesses that are already profitably engaged in this type of financing. Whether the
Bank sells these products in-house or acts as a broker agent for another company,
offering these products through the SME banking distribution channel will build TDBFG's
reputation and signal to the market that it is an aggressive player in the SME lending
arena.
A conservative product addition would be re-launching margined lines of credit to
customers with limits in the $250 thousand to $1 00 thousand range. This product
usually margins a percentage of accounts receivable, inventory or marketable securities
but was discontinued in 1998 due to the high monitoring costs that made it unprofitable.
Cost reducing alternatives may make this a viable product.
2.8.5.2 Automotive Financing
An extension of new product development is modifying existing personal
products to serve the SME market. Presently TDBFG offers vehicle financing to
individuals through car and truck dealerships nationwide. Often SMEs will finance
company vehicles in this fashion because of convenience. TDBFG should expand this
product to include vehicle financing. Likewise, the personal bank has developed a loan
product, which simulates a vehicle lease. This product could also be expanded to be
available to SMEs.
2.9 Alternative Rapid Penetration Strategy The alternative strategy will result in market share gains, however it involves
serving a niche of the SME market and embraces fewer of the key success factors
identified earlier in Chapter 2. In order to gain market share in the SME lending industry
with a conservative organizational and capital commitment, TDBFG should maintain the
existing rapid penetration strategy used for small business customers with the lowest
price in the market and relationship management for small enterprises handled Financial
Advisors. The product line and application process would be simplified so that SBAs
can be phased out, as they are more expensive than Financial Advisors and employees
of lower expertise can sell the simplified product. This would be coupled with a market
development strategy leveraging the cross sell opportunities presented by the larger
market share in personal banking. This strategy would be supported by process
improvements and credit scoring technology in order to reduce costs and reduce the
need for expertise in the sales force. TDBFG would retain a generalist approach to
managing the customer relationship and advertise its through low cost channels. Finally,
the bank would look for opportunities to modify personal banking products to be sold to
SME customers. These modified products would be sold through alternate distribution
channels such as car and equipment dealers. Medium enterprises would continue to be
served by TD Commercial Bank.
This strategy would focus on and retain low risk small business customers whose
credit needs are simple and require little monitoring. These simplified products would
filter out small business customers who do not fit the generalist profile. This strategy
would retain its targeted small business sub-segment and over time would attract low
risk, price sensitive customers from other institutions. Customers would also benefit
from having one contact for all their personal and business banking needs. The
commercial bank would pursue a similar low cost and low price distribution strategy,
however a relationship manager specializing in medium enterprise lending would serve
these customers.
Price demand is relatively inelastic however there is a sub segment of SME
customers that is price sensitive and will switch. As well, many SME customers want to
deal with relationship managers who have expertise, which this strategy will not provide.
This strategy will result in rapid short-term market share gains however as a niche player
TDBFG will not win a dominant market share. The benefit of this strategy is that other
banks cannot match the low prices without dismantling their high cost distribution
channels. Its weakness is vulnerability to a new entrant who does not share the cost of
a bricks and mortar distribution channel.
2.9.1 Credit Scoring Technology
TDBFG will have to licence credit-scoring technology and customize it to reflect
its low cost objectives. Customization will be kept to a minimum to reduce maintenance
and upgrade costs to the system.
2.9.2 Credit Management Technology
There is a great deal of duplication in the credit management area. Credit
management technology presently results in costly duplication. An interface would be
developed for SME bankers so that the data they input is automatically fed to the credit
scoring system without having to be input a second time.
2.9.3 Organization & Compensation Structure
In order to reduce distribution costs the SME business at TDBFG should adopt a
simpler organization structure.
Three distinct groups should service business banking as per Table 6. This is
the same market segmentation strategy currently employed by the Bank. TD Canada
Trust would service more than just small business borrowing customers. Financial
Advisors would manage all products that serve small businesses in addition to the
Bank's personal offerings. FAs are located in retail branches in geographic proximity to
their customers.
Loan authorizations under $250,000
Day-to-Day business banking needs
Basic Cash management services
Loan authorization greater than $250,000
Deposit & investment balances greater $250,000
Cash management services
Table 6: Business Segmentation under Alternative Strategy
63
FAs would maintain a mixed portfolio of 150 to 200 personal and small business
customers. The corporate reporting structure would remain the same for medium
enterprise lending, and FAs would continue to report to their Branch Manager.
2.9.4 Product Development
TDBFG presently offers vehicle financing through car dealerships; this would be
extended to business customer, while the credit approval would still be based upon the
owner's personal credit worthiness. The same modifications would be made to PAAL
loans, which are loans, offered by the bank and simulate vehicle leases.
3 CHAPTER THREE: INTERNAL ANALYSIS OF SME LENDING AT TDBFG
TDBFG's ability to implement either of the above strategies hinges on its internal
capabilities. The assessment of these internal capabilities will follow the Diamond E
The internal analysis will take inventory of the required resources,
management preferences, and organizational capabilities necessary to execute the
optimal strategy. It will then identify the gap between the necessary and actual
resources and capabilities. Finally, the internal analysis will address the gap and
determine how TDBFG will close the gap. If it cannot close the gap then it should adopt
the alternative strategy, which requires fewer resources and capabilities.
3.1 Resources In order to engage in the optimal strategy, TDBFG needs significant resources.
Many of these resources are readily available and play on existing strengths at TDBFG.
Other resource requirements present significant gaps that need to be addressed.
3.1.1 Culture
The Bank will be building a 1000 employee distribution network, almost from
scratch. The existing network relies of 100 Small Business Advisors and fewer than 100
specialists from the commercial bank who serve medium enterprises. Not all of the
existing personnel are suited to the sales and service culture and not all of them will be
hired into the new SME banking business unit. Given the large intake of new SME
Bankers within a one-year period, the Bank will need to indoctrinate them with the new
SME banking culture and the desired customer relationship management model. This
37 Fry, Joseph N. and J. Peter Killing. Strategic Analysis and Action, fourth edition. Scarborough: Prentice-Hall Canada, 2000. 39-50
65
will require significant training and team building resources to be placed at the disposal
I of the SME banking business unit. In the past 2 years, TDBFG has run an intensive
one-week training program for managers at TDBFG. This training is similar to that which
would be needed for the SME bankers. The week could be modified to suit the new
needs and could be extended by one week to allow for technical training on systems,
processes and structuring credit. The Bank also has experience indoctrinating the TD
Canada Trust culture after the merger as well as the absorption of Laurentian Bank
employees.
In order to support this cultural acclimatization, TDBFG must ensure that systems
and processes are appropriately aligned to the sales and service culture. This will be
explored later in the chapter.
3.1.2 Marketing
TDBFG has excellent brand management experience both with TD Canada Trust
and TD Waterhouse. In this case, SME Banking will be brought under the TD Canada
Trust brand. This reduces the challenge for SME Banking, because the business unit
does not need to build a brand from scratch. It does present challenges, because SME
banking must live up the brand proposition. Living up the brand proposition is addressed
by the other components of the strategy.
In order to hire SME Bankers, marketing will first have to look at the market
segment demographics to create 900 portfolios that are both profitable to service with a
relationship manager and have sufficient growth potential. Once the portfolios are
created, the territories can be allocated and the hiring process begins.
3.1.3 Sales & Distribution
In the first year the Bank will hire 900 SME Bankers, 100 per region. However
they will not be allocated evenly to each region. SME Bankers will be located based on
geographic customer concentrations. Nine hundred SME Bankers is fewer than
TDBFG's closest competitors, however the sales force can be incremented to reinforce
the geographic areas experiencing the greatest growth.
Potential hires will come from the existing SBAs, medium enterprise bankers, the
TD Canada Trust personal banking sales force, other business units and external hires.
SME Banking will hire for personality and suitability to the sales and service culture. The
900 SME bankers will be hired in two waves of 450. Availability of suitable candidates is
expected to be moderately high.
TDBFG will also need 54 SME District Managers paralleling the existing 54
personal bank districts. These individuals will be expected to have a higher level of
expertise, and can be drawn from SBAs, the Commerial bank and SME bankers from
other Financial Institutions. The availability of these hires will be moderate, however the
Bank has the financial resources to attract the right people.
Finding offices for all of these SME bankers presents another logistical challenge
that will be handled by Real Estate Management. Real Estate performs fixed assets
management functions. It works with the district manager, and ensures that offices are
furnished appropriately and that leasehold improvements are made to address the
Bank's needs. Design and construction is fairly straightforward however branches have
very specific needs and although some branches have available space to accommodate
a SME Banker, some would require expansion or significant renovations. The more
capital-intensive proposals would be evaluated to ensure that the Bank would gain
adequate return on investment. Real estate management does not present a significant
obstacle to this strategy.
The SME specific hotline involves reallocation of existing call centre resources, it
also involves SME product and systems training for existing telephbne representatives.
This is a small shift in functionality.
3.1.4 Systems & Processes
TD Canada Trust currently uses a Customer Relationship Management solution
called Clear Customer Choices (C3). C3 is intended to support customer sales
interaction. C3 supports TD Canada Trust's Customer Experience Model and Guiding
Principles, and assists with product comparisons and recommendations. It is a
customer centric tool that invites the customer into the conversation and allows
employees to readily share information. Most importantly, C3 signifies the
comprehensive choice of products and services available at TD Canada Trust. C3 can
be easily upgraded with enhancements for SME and to capture the information
necessary for SME applications for a variety of products.
The Bank has already taken steps to improve credit scoring technology for deals
$50 thousand and under. This will be implemented in 2005 and will assist the Personal
Bank in servicing smaller volume customers who will no longer be looked after by SBAs.
The Bank should investigate other credit scoring technologies to assist in credit
decisions as large as $1 million. The most cost effective solution will be licensing the
technology however, in the future as the Bank gains market share, building the
technology in-house may prove cost effective and could become a source of sustainable
competitive advantage. Although, the Bank presently lacks credits scoring technology
for larger credits, there are many suppliers willing to licence the technology. For
example, now that Wells Fargo has exited the Canadian business lending market, it may
be willing to licence its technology for the Canadian market alone. Wells Fargo is
recognized as an industry leader in SME credit scoring technology. Other foreign
financial institutions will likely entertain the same opportunity to gain additional cash flow
from their sunk costs in credit scoring technology.
Credit management must be developed in-house. Credit management ties into
risk management practices, credit and loan production processes, all of which heavily
impact cost of production. Since cost of production is a core competency at TDBFG, the
Bank cannot afford to lose control of this function to a third party supplier. It can
however reduce development costs by contracting out some of the less sensitive
software development offshore under close scrutiny. Process improvements may
involve acquiring the services of management consultants. The Bank frequently uses
management consulting services to assist in designing best business practices. Any
best practices learned from consultants must quickly be built upon and customized for
competitive advantage, since the same best practices gained from consultants are sold
to every competitor in the marketplace. As well, advantage can be gained by the
effectiveness with which best practices are implemented. TDBFG has a culture that is
accustomed to change, given its industry. As a result, it can gain advantage through
superior change management and process improvement implementation. The Bank has
the tools to overhaul credit management.
Cross sell technology is needed to deepen customer relationships and build
retention. The Bank presently uses a system licensed from Peoplesoft called Radar &
Leads. In the micro lending arena, this system can identify customers who are likely to
want and will qualify for credit products, with 99% certainty of approval. As the SME
customer relationship technology is enhanced, the Bank will be able to expand the
capabilities of Radar & Leads to identify cross sell opportunities in this market segment
as well. This enhancement would be part of ongoing system enhancements. The Bank
currently operates enterprise solutions from both Peoplesoft and Qracle. It may gain
greater functionality from consolidating with one ERP provider.
The prospect of licensing and purchasing technology, as well as the possibility of
building some process functionality offshore creates significant operational, security and
host country risks. The Bank already has a department devoted to outsourcing and
third party vendor management.
Since outsourcing involves the transfer of the management of a function to a third
party vendor there are operating risks that been to be accounted for. Outsourcing
Management is responsible for managing these risks including increased reputation risk,
loss of control due to transfer of management to the outsourcer and increased risk of
loss of the function or process in the event of outsourcer failure. Outsourcing
Management ensures the riskheward decision of outsourcing is carefully analysed
before entering into any outsourcing arrangement. The Bank's current capabilities can
manage the incremental licensing and outsourcing arrangements proposed by the SME
strategy. The Bank should hire consultants when engaging in offshore outsourcing,
since the Bank has limited experience in this area.
Striving to create best in class processes for managing procurement
expenditures, Vendor Management is being developed into a centre of competency
within the Bank for evaluating, negotiating, structuring and managing supplier
relationships and sourcing agreements. To fully leverage the Bank's procurement
power, Vendor Management is responsible for negotiating supply agreements, which
offer the best combination of service, quality, and pricing, with the objective to reduce
the Bank's non-interest expenses by an estimated $1 30 million annually. The Bank
manages some of its mutual funds, however third parties manage many of them:
Symcor handles cheque and payment processing, the Bank partners with Ceridian to
provide payroll services, it has partnered with First Data to provide merchant Mastercard
services, Brinks services the Bank's ATMs and processes deposits accepted through
them, and Iron Mountain performs the substantial task of categorizing and storing
documents, which need to be retained up to seven years. As well, the Bank contracts
out a great deal of market research and advertising functions. The list of outside
suppliers is very large.
3.1.5 Credit Policy & Risk Management
The Bank has limited experience with asset lending. It does have a subsidiary
for leasing heavy equipment however only for unit volumes greater than $100 thousand
and the leasing subsidiary maintains separate distribution. The Bank has developed a
lease-like loan for personal customers called a Payment Advantage Auto Loan this is
delivered through a partnership with Curomax Corp, which specialized in dealer
financing of automobiles, leisure and recreational vehicles, and home renovations.
Curomax also contracts its services to RBC, HSBC, BNS and Wells Fargo. The
Curomax offering is integrated in the C3 platform.
Similar deals could be struck to allow the Bank to offer factoring, financing of
work in progress, and low loan-to-value property financing where cash flow is not
evident. It would also allow the Bank to become a more aggressive player in
commercial real estate financing for investment purposes. The Bank generally shies
away from financing real commercial estate that is not owner occupied.
The Bank has laid down the framework for financing through business partners.
This process can be repeated with SME products in mind.
3.1.6 Resource Gap
TDBFG has a large resource base and can draw upon from the whole portfolio of
financial services. In 2003, The Bank showed willingness to use these resources when
it purchased all of the Laurentian Bank branches located outside of Quebec and it
purchased Boston based Liberty Mutual Group. TDBFG is willing !o put the right people
in charge and give the access to significant monetary and human capital. There is also
recognition within the organization that a significant investment will be necessary in
process re-engineering and information systems related to SME banking.
Although some resource gaps have been identified, they are similar to
shortcomings the Bank has faced in the past and has overcome. Below in Table 7 is a
summary of TDBFG's resource strengths and weaknesses.
Culture TD Canada Trust has a strong training program Not all existing SBAs and Medium Enterprise to support sales and service culture. Bankers buy into sales and service culture. As
a result will not be rece~tive to customer centric
Sales & Large pool of suitable candidates to fill new With the volume of hires in such a short time Distribution SME Banker positions. frame, there is a risk of compromising the
Manybrancheshaveunusedspaceandcan personality attributes necessary to preserve the accommodate new offices for SME Bankers. customer centric culture.
0 e.Bank already successfully operates Some branches will require capital
r personal and small
Credit Policy & TDBFG has experience acting as an agent for SME products are more complex and create Risk Management business partners in order to offer innovative additional process challenges when dealing
products. with business partners.
Table 7: Resource Strengths and Weaknesses
3.2 Management Assessment Senior management is strongly committed to increasing market share of this
customer segment. As the industry becomes more competitive in this mature industry
there are fewer opportunities to grow outside of mergers and acquisitions. Interest rate
spreads are at historical lows in Canada and banks are realizing that the SME market, if
served efficiently, can provide higher margins than other market segments. As well, the
market share imbalance between personal and SME banking at TDBFG provides a
unique opportunity. Ed Clarke, CEO of TDBFG and Andrea Rosen, Vice Chair of
TDBFG and President of TD Canada Trust, have both orchestrated the merger of TD
Bank and Canada Trust to form TD Canada Trust. They have also successfully
absorbed the over 50 branches recently acquired from Laurentian Bank. Having
completed these two large-scale transactions and the organizational alignment shifts
associated with them, these two senior executives now have the time resources and the
will to oversee a strong strategic initiative in SME banking. They have communicated
this intent by assigning one individual, Bernard Dorval to manage the commercial bank,
Small Business Division of TD Canada Trust and TO Meloche Monnex. His mandate is
to formulate a comprehensive strategy for business banking and prepare that strategy
for execution. All of the afore-mentioned executives have backgrounds in banking and
would each be very capable of engaging in a strategic reorganization. Their greatest
challenge will be developing asset lending.
The greatest potential management barrier to change is the current structure of
business banking. Presently, medium enterprises are served by the commercial bank
and small enterprises by TD Canada Trust. If both small business and medium
enterprises were to be served by one business unit, one of these businesses would lose
influence over their market segment. This would have the greatest impact on Paul
Douglas, SVP Commercial Banking and Tom Dyck, SVP Small Business Banking,
Merchant Services and Insurance. Neither of business unit leaders had a hand in
formulating current business strategy, so they are less likely to res/st change. Paul
Douglas was recently re-assigned from Investment Banking where he presided over a
reorganization of that business unit. Tom Dyck joined the Business Products Group in
2002 after the merger of TD Canada Trust and has experience in several other areas of
banking including the personal bank, wealth management and information systems.
3.2.1 Management Gap
Management is fully committed to change in the delivery of services to the SME market
segment. The executive maintains fairly centralized control over bank strategy. If they
buy in to the strategy then everyone in a tactical position will fall in line. Table 8
summarizes management's strengths and weaknesses.
I Culture The SME Bankinq Group will be a division of I TD Canada rust which already has a strong management commitment to a customer centric
Sales & TDBFG is aware of its weaknesses and has TD Commercial Bank will lose influence over Distribution publicly committed to turning this business medium enterprise banking.
around.
Imbalance in market share between personal banking and business banking presents a tremendous opportunity.
TDBFG has recently completed two large-scale mergers in the distribution network and has the necessary competencies to undertake more.
TDBFG has under performed in the SME market for the past five years and management
Credit Policy & TDBFG has undertaken similar projects in the SME lending involved greater complexity and Risk Management past. may proposals may be met with resistance ,
from k isk ~ a n a ~ e m e n t .
Table 8: Management Strengths and Weaknesses
3.3 Organization
3.3.1 Organizational Capabilities
TD Canada Trust has a cultural fit that is aligned with the strategies presented.
The Bank has been preparing for a re-launch of a SME banking initiative and there is an
expectation that the individuals currently serving this group will be re-organized. There
is a credible public commitment to build the Bank up to first or second rank in market
share in Canada. The incumbent SBAs and Medium Enterprise Bankers do not all share
the TD Canada Trust customer centric culture. In the past four years since the merger
of TD Bank and Canada Trust, their business units have been largely untouched by the
changes, which swept the rest of the organization. Although this presents an obstacle,
TDBFG presently has less than 200 people devoted to this market segment. Much
fewer than the nine hundred dictated by this strategy. Not only are they a minority, but
also since the SME Business Group is being created as a new business unit the Bank
can ask the incumbents to reapply for their positions within the new organization. Job
accountabilities and objectives will change, as well as performance measurement and
compensation. Those incumbents who are unsuited to the new business model will be
screened, and attempts will be made to find them positions in other parts of the SME
lending value chain such as credit adjudication and prod~ction.~' It is important that
these individuals still have high service skills even to work in back office functions.
Current training programs are ill suited for SME Bankers. They are either
directed toward micro lending or mid-market. Over the past three years, TDBFG has
designed new training maps for its management, sales and service people within the
personal bank. It will have to use the skills gained in the rollout of the retail strategy to
38 This is a trend in banking and ultimately impacts the effectiveness of the back office functions. As the back office absorbs more people who are not service oriented it becomes a less customer centric business unit while the rest of the organization becomes more customer centric.
implement a rollout of the
learning map and training
SME Banking strategy, including designing a SME banking
courses specifically for this group.
Another advantage of creating a new business unit is that in the process of hiring
SME bankers, management can ensure buy-in. Management must be up front about the
changes taking place and sure that potential members are aware that the new culture
espouses observational coaching of customer interactions as well as focused coaching
to business objectives. For some of the incumbents this is a significant change in
management style.
3.3.2 Organizational Changes
TDBFG, in undertaking this strategy, is making dramatic changes to the way it
serves SMEs. It is also making dramatic changes in its reporting structure in order to
maintain focus on the market segment.39 This is not unlike TDBFGs recent restructuring
of wealth management. In that restructuring it engaged in a hiring and training initiative
in the financial planning division of its wealth management unit. TDBFG has the ability
and experience to support a targeted hiring and training program to build its SME
banking capabilities.
TDBFG also re-organized its wealth management business on a larger scale. It
recently brought financial planning and full brokerage services under its TD Waterhouse
banner, previously reserved for discount brokerage. They used to operate as separate
independent businesses. Now discount brokerage, full brokerage and financial planning
all fall under the TD Waterhouse wealth management group re-focusing the wealth
management business to avoid channel conflict and extract the benefits of coordinated
marketing, relationship management and information systems.
39 See Appendix B
That reorganization is similar to the one being undertaken in business banking
and it shows that TDBFG has the organizational flexibility to undertake dramatic
reorganization.
The SME initiative also involves some risky initiatives, especially in the area of
licensing technology, using third pa8rty vendors and offshore business functions. The
Risk Committee of the Board considers risk and associated trends in risk for the Bank,
approves risk management policies, oversees the management of all risks and monitors
the risk profile of the Bank. Each business unit is responsible for its own business risk,
however these business units report to the Risk Committee. The Risk Committee
reviews and interprets risk based on the Enterprise Risk Framework seen in Figure 12.
The primary focus of risk management is market, credit and operational risk. To this
end, Risk Management must identify risks, articulate them to the business units and
provide advice on the shareholders' level of acceptable losses. Risk management then
oversees the business units to minimize the level of unexpected losses, and provide an
independent assessment of the risk and control infrastructure.
Figure 12: Enterprise Risk Framework
TDBFG has
endeavours without
the controls to effectively engage in these potentially risky
placing the organization at unreasonable risk. I
Another possible outgrowth of rapid change in the Bank is that business priorities
may overshadow regulatory compliance. Compliance is responsible for ensuring that
the Bank and its subsidiaries are aware of the legislation and regulations under which
they are governed, and that policies and procedures are developed and implemented to
ensure that line management is adequately equipped to comply. This is achieved
through presentations, participation in department meetings, written circulars and on site
surveillance of operating units. Line management is responsible for compliance with
regulatory requirements. All line Compliance Officers, while working closely with line
management, report directly to the Senior Vice President Compliance. TDBFG has the
systems in place to ensure that the SME Banking Group will incorporate compliance into
its training and ongoing management of the group.
3.3.3 Organization Gap
The gap in organizational capabilities is greater than the resource gap, primarily
due to the shift to a customer centric culture and a new distributions structure. The
organizational strength and weaknesses are summarized below in Table 9.
There is a shortage of trained individuals who have experience in SME lending
but who also have character traits that make them suitable for a sales and service
culture. The skill gap is unavoidable since the objective is to dramatically increase the
number of relationship managers in the field. The culture and character gap among
experienced employees only serves to reduce the number of people the Bank can hire
from existing operations. With comprehensive training an ongoing coaching the skills
gap can be closed.
The change in reporting structure appears to be a dramatic change on paper,
however the change would impact only the branches that presently have SBAs and the
Commerial bank offices. The gap is not that great in practice and is a surmountable
obstacle. Three years ago, the SBAs reported to a regional manager and had a similar
relationship with the branch as the one proposed in this strategy.
People TD Canada Trust has a strong sales and Some SBAs and Medium Enterprise Bankers
service culture. Management and people will resist a sales and service culture. They drawn from this group will propagate the culture may not find a place in the SME Banking Group within the SME Banking Group. that suits their personal characteristics.
Performance Performance will be measured using a This may be a change in performance Measurement balanced scorecard. Emphasis will be placed measurement for team members who do not
Management One of the cornerstones of the SME Banking The success of this management approach is Processes Group's management will be ongoing dependent on the managers' coaching abilities.
behavioural coaching to the Customer Experience ~ o d e l . ~ ' Management will also engage in regular focused coaching to business results.
Leadership The Bank has many suitable candidates for Not all leadership candidates have backgrounds in SME lending.
Table 9: Organization Strengths and Weaknesses
40 See Appendix D
I 4 CHAPTER FOUR: RECOMMENDATIONS
4.1 Overview Ed Clarke has made a public commitment to realizing the potential for market
growth in business banking. He has reorganized his reporting structure to ensure Bernie
Dorval, who is in charge of strategy for high growth potential businesses, reports directly
to him. As well, in the past TDBFG has shown a willingness to undertake swift and
dramatic change in order to seize business opportunities.
4.2 Strategic Recommendation Given the organization's strong commitment to gain market share in the SME
banking and more specifically SME lending market segment, TDBFG should undertake
the optimal strategy seeking rapid penetration. In order to implement the strategy and
bring about change in the organization, senior management first has to communicate its
vision for the new SME Banking Group, it needs to create a sense of urgency, and it
needs to put the right people in charge of the project. The project team will be the
architects of the implementation and must test the design to ensure a smooth
implementation. Finally, as the new business unit transitions beyond the start-up stage,
systems must be in place to look for opportunities and evolve the strategy as the
industry environment changes.
4.2.1 The Vision
The Bank's commitment will be to provide Small and Medium Enterprise
Businesses with the very best service from their relationship manager, in the branch,
over the phone and on the Internet. Their business is TD Canada Trust's reason for
being and the Bank appreciates the opportunity they have provided to help meet their
financial needs.
Customers demand quick and efficient service and they want to leave with the
right product or service the first time. As well, they expect accuracy and for all their
financial transactions to be completed error free. They are willing to forgive errors, but
only if they are corrected quickly and transparently.
4.2.2 Urgency
Service excellence is the difference between TDBFG and its competitors. As
evidenced by the Bank's depressed market share, the Bank must move quickly to regain
its reputation for customer service in the small and medium enterprise market. To do
this, the Bank must align its people, structure, products and processes to serve SMEs.
This precipitates the creation of the SME Banking Group. All of this must be done while
maintaining a low cost operating design. TDBFG cannot profitably deliver exceptional
service without maintaining a low cost of production.
Patching will allow the Bank to move quickly to refocus on SME customers,
without interrupting existing operations serving that market.4' Patching involves frequent
small reorganizations that keep the organization focused on the strategic objectives but
do not involve rolling out the entire strategy at once.
4.2.3 Project Team
The Bank must ensure that all the stakeholders are represented in the Project
Team and that they all buy into the vision. The project management team will be
composed of five individuals drawn from the key stakeholders. Some key players
include:
41 Brown, Shona 1. and Kathleen M Eisenhardt. "Patching: Restitching business portfolios in dynamic markets". Harvard Business Review MayIJune 1999: 72-83.
81
Business Product Group.
Insurance Product Group.
Small Business Credit.
Group Risk Management.
Learning & Development.
Operational Risk.
Information Systems.
Retail Sales & Service.
Small Business Sales & Support.
Indirect Credit Centre.
Credit Administration Services.
Enterprise Technology Services.
TD Canada Trust Marketing.
TD Canada Trust Human Resources.
The project management team will involve stakeholders in the design of the
implementation plan for the SME Banking Group. The project management team will
operate with accountability to reach specific measurable targets with respect to Culture,
Marketing, Sales & Distribution, Systems & Processes, and Credit Policy & Risk
Management. The strategy must be fully implemented one year after the project
management team is formed. Speed is necessary in order to take advantage of
momentum. A slower implementation timeframe is more likely to meet with resistance.
4.2.4 The Devil in the Details
The most challenging aspect of implementing a new strategy is change
management. On of the advantages of building the SME Banking Group from an
existing combined sales force of less than 200 is that the new SME Banking Group will
not be burdened by an incumbent culture and it can hire based on personality and
cultural buy-in. The goal is to double TDBFGs market share within four years of
successful implementation of the new strategy.
4.2.4.1 People
A large part of the sales force used to service SMEs will be new hires and
trainees. The company should seek out employees within TD Canada Trust whose skill
set is complementary to a growth strategy. TDBFG will also look for new hires from
outside the Bank however it will not poach business bankers from other organizations as
they will, more often than not, bring preconceived ideas as to how to approach the
business and may resist adopting the TD Canada Trust culture. To a great extent the
Bank will hire for personality. Other skills can be learned. The Bank should seek
influencers, individuals who are suited to sales. These individuals are very sociable and
prefer working environments that involve a great deal of customer and team
in tera~t ion.~~
4.2.4.2 Reinforcement Systems
Reinforcing desired behaviour is essential to change management. TDBFG will
do this by designing a balanced scorecard for SME Bankers and tying it to
compensation. The scorecard will be weighted in favour of new customer acquisition.
New hires will begin at lower salaries than average with greater rewards for
performance, consistent with practices in the personal bank. The weakness of the
42 Butler, Timothy and Waldroop, James, Understanding "People" People, Harvard Business Review, June 2004, p. 79
scorecard it that it only measures the results of desired behaviour;,it does not measure
the behaviours themselves. In order to ensure that SME Bankers are developing the
necessary skills to succeed, their managers will provide ongoing and frequent
behavioural observation coaching. Managers will attend training courses to fine-tune
their coaching abilities. Managers will also be observed coaching and their supervisors
will "coach the coach".
4.2.4.3 Systems & Processes
Systems and processes need to be aligned to the business culture and vision.
The goals are ease of use, speed, transparency and low operating costs. The Bank can
afford a high initial investment, however the ROI must beat the benchmark. The goal is
to meet a service commitment of twenty-four hour turnaround on 80% of SME financing
transactions.
TDBFG will add features to its current customer relationship management
software to allow it to capture the relevant information for SME lending. This CRM
system will interact with proprietary credit adjudication system, which employs a
modified credit scoring system. Lending guidelines will be fine tuned to balance sales
growth against risk management and credit policy will require only the information
necessary for the loan decision. In order to meet the twenty-four hour turnaround
target, many intermediary processes will need to be automated and offshore resources
employed.
4.2.4.4 Structure
The structure of the SME Banking Group will be aligned to the market segment
rather than product groups or functional areas. Members of product development, credit
adjudication and loan production who are devoted to the market segment will all attend
the same introductory training as the SME Bankers to introduce them to the vision of
SME Banking and the Customer Interaction Model and their role in the customer
experience. This will also allow them to personally meet the other members of the SME
Banking team with whom they speak on the phone daily.
In order to maintain focus on this market segment and ensure that its efforts are
coordinated with the Personal Bank, the reporting structure for SME Banking will run
parallel to the Personal TD Commerial Bank, now focused on Mid-market and
junior corporate, will continue to operate in loose partnership with TD Canada Trust and
remain fairly unchanged. The SME Banking Group will locate its relationship managers
closer to the business customers in order to maintain the greatest focus on the targeted
market segment.
Small business credit adjudication ( A C C ) ~ ~ will be augmented in order that it may
take over the adjudication for medium enterprise lending currently handled by G R M ~ ~ .
ACC has been able to serve its market well while keeping production costs low, whereas
GRM has been unable to sufficiently lower the costs of the medium enterprise
adjudication process in order to maintain a competitive stance. Processes must be
improved to release SME Bankers from administrative duties and ensure they focus on
customer retention and business development.
4.2.4.5 Skills & Knowledge
Learning and Development has a principal role in preparing SME Bankers to
deliver their accountabilities and objectives. Training will focus on Product Knowledge,
Credit Adjudication, Legal Documentation, Sales Conversations and how to incorporate
those skills and knowledge into a natural Customer Interaction.
43 See Appendix B 44 Area Credit Centre 45 Group Risk Management
4.2.5 Vigilance
Strategy is not static. It is dynamic and will change as a re ult of future changes
in the environment, internal factors and competitors' responses to TDBFGs execution of
its strategy.
The Bank must set an expectation that the SME Banking Group remain vigilant to
changes that affect strategy and also look for opportunities to leverage its current
strategy. Some future innovations might include customized repayment schedules
which would peak and trough to match seasonal business cash flow fluctuations but
maintain the same amortization. The Bank keeps records of a large percentage of
customers' financial transactions and could partner with a financial software company to
provide up to date business financial statements through its Website for a monthly fee.
The Bank has aggregate data on hundreds of companies in many industries and this
information could be sold to customers to assist in benchmarking performance
measurement.
4.3 Conclusions In a mature market like SME lending that is characterized by high competitive
rivalry, market share can only be gained at the expense of competitors. In this scenario
a rapid penetration strategy will result in the highest possible market share gain for the
Bank.
In order to gain SME lending market share it is not sufficient to only match the
offerings of the competition. TDBFG must exceed selected capabilities presented by its
competitors. The Bank must distinguish itself by consistently delivering excellent
customer service to meet its brand value proposition. Excellent service can only be
delivered profitably if production costs remain low. TDBFG already possesses an
organizational core competency in low cost production. It can transfer these skills to
reducing cost of production in SME lending and allow it to serve customers who would
not generate an economic profit for competitors. This, combined with a sales force with
superior focus on the target market segment, will enable TDBFG to gain market share.
These two primary strategies supported by new product development and superior cross
sell systems directed at the personal customer base will lead to success.
TDBFG has the management support, the resources and an organization that is
accustomed to change. With these aligned to the new strategy, TDBFG will succeed in
implementing an aggressive and rapidly implemented strategy that will result in
increased market share in the SME lending market. Ultimately this strategy is only the
next step in SME Financing at TDBFG, it is not a long-term road map.
5 APPENDICES
5.1 Appendix A: Business Loan Product Life Cycle
Product Development
Marketing & Support
Customer Customer Contact Application
Underwriting & Offer
Customer Customer Contact Acceptance
Prepare Documents
Customer Contact Customer
Signs
Bank Funds
Collects Payments
Customer Contact Service &
Support
5.2 Appendix B: SME Banking Reporting Structure
President TD Canada
Trust
Business Banking r l
Regional VP SME Banking
SVP Commercial
Manager Manager Manager Manager SME Banking SME Banking SME Banking SME Banking
SVP SME Banking
VP Merchant
Bank
1
Services
SME Banker SME Banker SME Banker SME Banker
5.3 Appendix C: Loan Application Process Flop The Website would provide easy to understand explanations of each stage of the
process and would also provide explanations of the fundamentals of credit decision
making as well as definitions of different types of collateral used to support authorized
credits.
I
Resubmit Declined L I I I I I I I 4 PreEnted
5.4 Appendix D: Customer Experience Model
Be Ready Establish Rapport Ask how helshe can be of help
Explore Initial Need Check to Proceed Explore Business Profile and Financial Relationship Explore Additional Needs Summarize and Prioritize
Provide Advice or Recommend Actions Obtain Agreement Ask for the Business
Define Next Steps Check for Satisfaction Express Appreciation
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